3. TAXATION IN THE MAINLAND CHINA

3.5 CONTEMPORANEOUS TRANSFER PRICING DOCUMENTATION RULES

The contemporaneous transfer pricing ("TP") issue becomes one of the most critical concerns to enterprise with multi-national and cross-border operational business. Generally speaking, TP issue becomes crucial focus of the tax authorities on those multi-national corporations. In particular, PRC tax authorities will mainly focuses on the area so-called "RELATED PARTY TRANSACTIONS".

Recently, the State Administration of Taxation ("SAT") in PRC takes tight enforcement on TP documentation subject to Foreign Investment Enterprise ("FIE") and a set of detailed documentation requirement will be taken effect in the near future in parallel to the implementation of the newly revised Company Income Tax Law ("CIT") which is effective from 1 January 2008.

According to Article 109, of Chapter 6 of CIT, parties are defined as related parties if

 

1. In respect of financing, business purpose, sales and purchase of goods in which

parties have direct or indirect control relationship;

2. Have directly or indirectly been controlled by a common third party;
3. In terms of benefit side, have other relationship.

 

According to Article 110 of Chapter 6 of CIT law, parties without any relationship should make use of arm-length principle to carry out business transactions with the other parties.

 

3.51 THE CONTEMPORANEOUS TRANSFER PRICING DOCUMENTATION REQUIREMENTS

In order to meet the more stringent TP documentation requirements of the revised new CIT law, the following forms will be applicable.

Form	Name
1	The summary of related party relationship by type
2	The summary of the related party transactions by type
3	The summary of both purchase and sales transactions
4	The summary of the related party services transactions
5	The summary of related party financing transactions
6	The summary of the intangible assets
7	The summary of fixed assets
8	The summary of outbound investment
9	The summary of outbound payments

3.52 SERIOUS CONSEQUENCE IF NON-COMPLIANCE WITH THE CONTEMPORANEOUS TRANSFER PRICING DOCUMENTATION (“TPD”) REQUIREMENTS

If a taxpayer fails to comply and maintain the contemporary TPD, Consequently, the taxpayer may be deemed to subject to CIT liabilities by  the Chinese tax authority. The taxpayer is also subject to a special tax adjustment including the additional tax payment, the interest levy, tax penalty and the risk of other tax issues.

It is anticipated that the interest levy is calculated based on the benchmark bank loan interest rate set by the People’s Bank of China.

3.53 TRANSFER PRICING ISSUES

 

In carrying on business in the Mainland China, to most multi-national companies (“MNC”), their group goal to achieve the tax saving is to shift the group profit to those subsidiaries incorporated in some countries with low tax jurisdictions, one of the common practices is to implement careful tax planning – the adoption of transfer pricing methods.

 

The appropriate adoption of transfer pricing results in tax saving legitimately whereas the abuse of transfer pricing causes the alert of tax authorities and raises the issue of tax anti-avoidance measures, accordingly, certain tax adjustments are needed by the tax authority. The pricing policy in a transaction is a crucially important issue to management and thus how to technically make the commercial transaction feasible and on arm-length basis is always headache to MNC.

 

In respect of the issues of transfer pricing, there are 5 guidelines regarding the definition and its application promulgated by OECD (“Organization for Economic Co-operative and Development”) in 1995, the former conventions, it suggested that the tax authorities and the taxpayers should adopt the normal commercial basis. According to the Article 9 of OECD convention 1995 - the adoption of the arm-length transaction principle, it recommends taxpayer to set the prices comparable those adopted in these normal commercial transactions.

 

What’re the arm-length transactions?

 

There are neither any clear nor standardized definitions to explain the term “arm-length transactions”, but in the real-life market environment, these must be the consequences under the normal perfect competition.

 

Pursuant to the guideline OECD 1979, the am-length transactions principle should be involved the following factors:

 

(i)          the transaction analysis

(ii)        comparison and similarity:

(iii)       the private agreement arrangement;

(iv)      the feature of open market;

(v)        the feature of subjectivity; and

(vi)      functional analysis.

 

3.54 METHODS TO ASCERTAIN THE ARM-LENGTH TRANSACTIONS

 

There are six traditional methods to work out the arm-length transactions regarding the appropriateness of prices adopted in related party transactions under the transfer pricing issues:

 

According to Article 111 of Chapter 6 of CIT law, there are six traditional methods to work out the arm-length transactions regarding the appropriateness of prices adopted in related party transactions under the transfer pricing issues:

 

(i)          Comparable uncontrolled prices (known as CUP),

It is the method in which non-related uncontrolled parties have set the prices adopted based on the similar and comparable transactions basis to deal with the others.

 

(ii)        Resell price method (known as RPM);

The related party has purchased goods and then sold them to un-related party, the pricing policy is set when the selling price used less the gross profit derived from a transaction with similar nature transaction

 

(iii)       Cost-plus pricing methods (known as CPP);

It is the pricing method in which the cost incurred is marked-up with the necessary related expenses and profit-margin at the appropriate basis to work out the selling price.

 

(iv)      Transaction profit methods;

Among these non-related uncontrolled parties, they set the selling price to carry out business transactions with the others, so the net profit margin adopted in setting their selling prices is the norm in this pricing method.

 

(v)        Profit split method; and

It is the pricing method in which the combined profit or loss of the group of related parties is allocated to the individual related party on reasonable and appropriate basis.

 

(vi)      Other methods corresponding to the independent transactions basis.

 

In China, new CIT law became effective in January 2008, some important issues regarding the transfer pricing are:

 

Pursuant to Article 114 of Chapter 6 of CIT law, - the “connected information”

 

(i)          The provision of the contemporaneous information regarding the pricing setting criteria, expenses allocated criteria and their basis of calculation in the related party transactions;

 

(ii)        The provision of the contemporaneous information regarding the selling pricing information (transfer of interest) or the final selling pricing information (transfer of interest) of the related party transactions are involved in property, royalty fee in respect of intellectual property, and service fee, etc;

 

(iii)        When a related party is involved in a tax investigation case, other related party transactions dealt with it should provide the comparable information and profit margin information for such a tax investigation purpose;

 

(iv)      Other information in connection with the related party information.

 

Pursuant to Article 123 of Chapter 6 of CIT law, the enterprise has carried out transactions with its related party neither on independent transaction basis or without the appropriate commercial purpose, the tax authority has the right to make tax adjustments within the subsequent 10 tax financial years from the first tax financial year in which the enterprises had started to carry out such business transactions.

 

3.55 ADVANCED PRICING AGREEMENT (“APA”)

 

It is a tax arrangement in which the taxpayer is entered into a compromise agreement with tax authority concern regarding the pricing policy to be selected and adopted before adopted those in the related party transactions. Upon the application and get the confirmation from the tax authority concern, those pricing policies adopted are unanimously agreed not to be involved as tax evasion or the element of anti-tax avoidance. Such practice aims to avoid the tax adjustment made by the tax authority upon the transactions dealt with related parties.

 

(i)         Unilateral Advanced Pricing Agreement

 

The taxpayer has entered into a compromise arrangement with ONLY one tax authority concern regarding the pricing policies to be selected and adopted before adopted those in the related party transactions.

 

(ii)       Bilateral Advanced Pricing Agreement

 

The taxpayer has entered into a compromise arrangement with TWO tax authorities located in two different countries concern regarding the pricing policies to be selected and adopted before adopted those in the related party transactions. This can avoids the double taxation in two different countries in an excessive amount.

 

(iii)     Multi-lateral Advanced Pricing Agreement

 

The taxpayer has entered into a compromise arrangement with tax authorities located in THREE OR MORE different countries concern regarding the pricing policy to be selected and adopted before adopted those in the related party transactions. This can avoid the double taxation in three different countries in greater extent. As it is involved more complicated issues, it is observed that not many successful cases are found worldwide.