Development of Transfer Pricing Rules in China
Before 2009, China generally followed the OECD Transfer Pricing Guidelines. However, China later developed a more specific transfer pricing framework.
New transfer pricing guidelines were announced by the State Administration of Taxation (SAT) in March 2008 and formally issued in January 2009.
The Chinese guidelines differed significantly from the transfer pricing approach followed in many other countries in two major respects. First, the guidelines were issued mainly to instruct field tax offices on how to conduct transfer pricing examinations and make adjustments. Second, the factors examined during a transfer pricing analysis varied according to the transfer pricing method being applied.
Scope of the 2009 Transfer Pricing Guidelines
The 2009 Chinese transfer pricing guidelines covered a broad range of tax and transfer pricing matters. These included administrative matters, taxpayer filing and documentation requirements, general transfer pricing principles, comparability analysis, and procedures for conducting transfer pricing examinations.
The guidelines also covered the administration of Advance Pricing Agreements and Cost Sharing Agreements. In addition, provisions were included relating to Controlled Foreign Corporation examinations, thin capitalization, and general anti-avoidance measures.
Thus, the Chinese transfer pricing framework addressed not only the pricing of related-party transactions but also several broader areas of international and anti-avoidance taxation.
Revised Draft of 2015
On 17 September 2015, the SAT released a revised draft of the Implementation Measures for Special Tax Adjustment, commonly referred to as Circular 2. The revised draft was intended to replace the earlier 2009 guidelines.
The revised draft introduced three important new areas. These were monitoring and management, intangible transactions and intra-group services, and a new approach to transfer pricing documentation.
The revised framework therefore increased the focus on the ongoing monitoring of related-party transactions and on transactions involving intangible assets and services within a corporate group.
Transfer Pricing Documentation in China
Documentation Requirements under the 2009 Circular
Under the 2009 Circular, taxpayers were required to disclose their related-party transactions while filing tax returns.
The Circular introduced a three-tier system of documentation and reporting requirements. The applicable level of documentation depended on the total or aggregate value of intercompany transactions carried out during the year.
Taxpayers covered by the transfer pricing rules who had intercompany transactions of less than RMB 20 million during the year were generally exempt from reporting, documentation, and penalties.
Taxpayers with intercompany transactions exceeding RMB 200 million were generally required to complete their transfer pricing studies before filing their tax returns.
For taxpayers falling within the highest documentation tier, the transfer pricing documentation was required to include a comparability analysis and justification for the transfer pricing method selected.
Documentation Approach under the 2015 Draft
The 2015 draft introduced a revised and standardized three-tier transfer pricing documentation system.
The three levels of documentation were the Master File, Local File, and Country-by-Country Report.
The content and purpose of the documentation differed at each level. This approach created a more structured system for reporting information relating to multinational groups and their related-party transactions.
The draft also required certain companies to prepare and submit a Special File. This requirement applied to companies involved in related-party service transactions, Cost Sharing Agreements, or thin capitalization arrangements.
General Principles of Chinese Transfer Pricing Rules
Chinese transfer pricing rules apply to transactions between a Chinese business and its domestic or foreign related parties. Therefore, the rules may apply to both domestic and international related-party transactions.
A related party may be identified by applying any of eight different tests. These tests include 25% common equity ownership, overlapping boards of directors or management, significant debt holdings, and other specified relationships.
The transfer pricing guidelines apply to most types of transactions that may take place between related enterprises.
Transfer Pricing Examination and Comparability Analysis
The Chinese Circular instructs field tax examiners to review the taxpayer’s comparability analysis and transfer pricing method analysis.
The method of analyzing comparability and the factors considered may differ according to the transfer pricing method used.
For the Comparable Uncontrolled Price (CUP) Method, the Chinese guidelines prescribe specific functions and risks that should be examined according to the type of transaction.
These requirements apply separately to transactions involving goods, rentals, licensing, financing, and services.
In comparison, the Chinese guidelines relating to the Resale Price Method, Cost-Plus Method, Transactional Net Margin Method, and Profit Split Method are comparatively short and general.
Therefore, the Chinese transfer pricing framework provides more specific comparability guidance for CUP analysis than for certain other transfer pricing methods.
Cost Sharing Agreements in China
Chinese transfer pricing rules provide a general framework for Cost Sharing Agreements.
The rules prescribe a basic structure for such agreements and provide for buy-in and exit payments based on reasonable amounts.
A Cost Sharing Agreement is also subject to a minimum operating period of 20 years.
The taxpayer is required to notify the State Administration of Taxation within 30 days of concluding the Cost Sharing Agreement.
These requirements are intended to regulate the sharing of costs between related enterprises and provide a structured framework for cost-sharing arrangements.
Key Exam Points
Before 2009, China generally followed the OECD Transfer Pricing Guidelines. New Chinese transfer pricing guidelines were announced by the SAT in March 2008 and issued in January 2009.
The 2009 guidelines were mainly designed to guide field tax offices in conducting transfer pricing examinations and adjustments.
The guidelines covered transfer pricing administration, documentation, comparability, examinations, Advance Pricing Agreements, Cost Sharing Agreements, Controlled Foreign Corporations, thin capitalization, and general anti-avoidance.
The 2015 revised draft of Circular 2 introduced monitoring and management, intangible transactions and intra-group services, and a revised documentation framework.
Under the 2009 Circular, taxpayers were required to disclose related-party transactions with their tax returns.
The 2015 draft introduced the Master File, Local File, and Country-by-Country Report. A Special File was also required for certain related-party services, Cost Sharing Agreements, and thin capitalization matters.
Chinese transfer pricing rules apply to domestic and foreign related-party transactions.
A related party may be identified through eight different tests, including 25% common equity ownership, overlapping management or boards, and significant debt holdings.
Chinese Cost Sharing Agreement rules require a minimum operating period of 20 years and notification to the SAT within 30 days of concluding the agreement.