State Administration of Taxation (SAT). People’s Republic of China (PRC) Corporate Income Tax Law, Chapter 6, Articles 41 through 48 (effective 1 January 2008) and The Regulations on the Implementation of the Enterprise Income Tax Law of the PRC, Articles 109 through 123 (effective 1 January 2008). Detailed instructions in the form of a circular from the SAT (Administrative Regulations of Special Tax Adjustments) to tax auditors and taxpayers regarding special tax adjustments relating largely to transfer pricing have been drafted, but not finalized. These instructions are comprehensive and provide a structured approach to transfer pricing issues in China. It is expected that the final Circular will be released in mid 2008, and that this Circular will supersede all prior relevant regulations and rulings.
Tax Administration Guidelines for Intercompany Transactions (Guoshuifa No. 59 (1998)), Amended Taxation Management Regulations for Business Transactions between Associated Enterprises (Guoshuihan No. 143 (2004)). Implementation Rules on Advance Pricing Arrangements (Guoshuifa No. 118 (2004)). Notice Regarding Issues Concerning Capital Adjustments in Tax Administration Works Related to Transfer Pricing (Guoshuihan No. 745 (2005)). Investigations of Loss-Making Foreign Entities and Foreign Invested Entities with Single Manufacturing Functions (Guoshuihan No. 236 (2007)). Strengthening Transfer Pricing Investigations (Guoshuihan No. 363 (2007)).
In principle, the SAT recognizes the OECD guidelines and the relevant transfer pricing methods.
The SAT accepts a reasonable method. The SAT wil accept CUP, Resale Price and Cost Plus. Other methods, including the Profit Split, the Comparable Profits Method (CPM) and the TNMM, are also considered. For the TNMM, the profit level indicators most often used are operating margin and total cost mark-up. Balance sheet profit level indicators such as return on assets or return on capital employed are rarely used.
Article 48 of the PRC Corporate Income Tax Law stipulates that interest wil be applied to the under-reported tax resulting from special adjustments to tax payments, including transfer pricing adjustments. Article 122 of The Regulations on the Implementation of the Enterprise Income Tax Law of the PRC references Article 48 and states interest imposed on adjustments is based on the base renminbi (RMB) lending rate published by the People’s Bank of China plus an additional 5% interest penalty charge.
According to Article 122, the additional 5% interest penalty can be avoided if relevant materials can be provided and have been prepared in accordance with the rules.
Under the new law and implementing regulations, there is an implied requirement that taxpayers maintain contemporaneous transfer pricing documentation, but the language is not specific. However, the draft of Administrative Regulations of Special Tax Adjustments introduces contemporaneous documentation requirements and provides detailed information regarding transfer pricing documentation contents. It is believed that taxpayers should ready themselves for a contemporaneous documentation requirement.
Under current regulations, transfer pricing documentation must be provided upon request of the tax authority conducting a transfer pricing investigation or a formal audit. It is anticipated that the forthcoming new circular wil require documentation to be prepared before 1 June.
The statute of limitations for transfer pricing adjustments may vary, e.g., adjustments can be applied for a period of up to 10 years.
Prior to finalization of the circular, taxpayers must file an “Annual Declaration Disclosing Transactions with Related Enterprises” (Forms 13A or 13B) for the taxation year. Detailed related-party transaction information may also be requested by the tax authority during transfer pricing investigations or audits. Guoshuihan No. 363 (2007) prescribes that upon a transfer pricing investigation, taxpayers must complete the fol owing three forms: Function/Risk Analysis, Financial Analysis and Characterization of Functions and Risks. If the Circular is finalized along the lines of the draft, there wil be numerous and detailed forms that must be attached to the tax return of the filing entity.
The risk of transfer pricing issues being reviewed under audit is medium to high. 2007 witnessed the SAT perform adjustments of RMB 9 bil ion, an increase from 5.9 bil ion during 2006. The SAT continues to focus on enterprises that have sustained losses in the past, especially those paying intercompany service charges or royalties. With the release of the final Circular, we believe there will be an increase in transfer pricing audit activity in the coming years.
APAs are available in China. Guidance regarding the APA process and procedures is provided in the Implementation Rules on Advance Pricing Arrangements (Guoshuifa No. 118 (2004)). This wil be superseded by the Circular, which is anticipated to contain detailed guidance on the qualifications of a taxpayer to apply for an APA, on the nature of the application and on the process of concluding the agreement.
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