On September 17, China’s State Administration of Taxation (SAT) released a revised draft version of the “Implementation Measures for Special Tax Adjustment (Circular 2),” which will replace the existing Guoshuifa  No.2. It contains rules governing transfer pricing and covers other areas related to general anti-avoidance rules.
Largely consistent with the BEPS (Base Erosion and Profit Shifting) project launched by the Organization for Economic Cooperation and Development (OECD), the draft rules introduce three new sections: monitoring and management, intangible transactions and intra-group services, and also a new approach to transfer pricing documentation. While closely mirroring the guidance issued in the course of the BEPS project, there are some distinctive features of China’s draft regulations. Here, we highlight the key changes that apply when preparing transfer pricing documentation.
Stricter Documentation Requirements
The draft regulations provide two specific exemptions (previously three) from the preparation of contemporaneous documentation:
- All the related-party transactions are covered by an advanced pricing arrangement (APA)
- The company only conducts related-party transactions with domestic affiliate parties
A Three-tiered Approach to Transfer Pricing Documentation
One of the major changes in the regulation is that it completely revises the country’s approach to transfer pricing documentation. In accordance with BEPS’s requirement, the Chinese government will now introduce a three-tiered standardized approach to transfer pricing documentation for the first time, including:
- Master File
Provides an overview of the multinational enterprise’s business, covering the nature of its global business operations and its overall transfer pricing policies
- Local File
Contains detailed information on related-party transactions taking place between domestic affiliate companies, specifically in the context of China’s tax system
- Country-by-Country Report (CBC report)
Includes information relevant to the global allocation of the income, the taxes paid, as well as certain indicators of the location of economic activity among tax jurisdictions in which the multinational enterprises (MNE) group operate
Companies that meet either of the following conditions will need to submit the CBC report:
- The company is the ultimate parent company of an MNE group with a consolidated group turnover exceeding RMB 5 billion in the last fiscal year (lower than the €750 million threshold set by BEPS based on the current exchange rates); or
- The company is not the ultimate parent company of an MNE group, but has been designated to make the official filing by the MNE group.
Taxpayers with related-party transactions are required to prepare contemporaneous documentation (the master file and the local file) if they meet one of the following criteria:
- The yearly related-party purchase/sale of goods transactions (when toll manufacturing transactions are determined based on customs declared import/export prices of consigned materials and finished goods) are more than RMB 200 million
- The annual amount of other related-party transactions (excluding purchase/sale of goods transactions) are over RMB 40 million
- The company bears limited risks and has incurred losses
Additionally, the draft also requires certain companies to submit a so-called Special File for related-party service transaction, cost sharing agreements and thin capitalization. More detailed requirements for the submission of the special file are yet to be further clarified in the final version.
Based on the current draft, taxpayers that meet one of the following criteria need to prepare a special file:
- The company conducts related-party transactions of labor services
- Certain transactions are covered by cost sharing agreements
- The company has violated relevant stipulations of thin capitalization
Deadline to Submit Documentation
Enterprises are required to finish preparing the documentation before May 31 of the following year and submit documentation within 20 days of a request made by the tax authorities. Please note that all the documentation needs to be prepared in Chinese and sealed and signed by the company’s legal representative. Given that the deadline is earlier than the BEPS recommendation of December 31, the draft allows Chinese filers to apply for an extension.
Currently, the SAT is still working on the final version of the country’s new transfer pricing regulations. It is expected that the draft will be finalized by the end of 2015 and come into force as early as 2016.
“Compared to existing rules, the new draft further clarifies certain types of related-party transactions and makes clear the remit of tax authorities,” says James Zheng, Senior Tax Specialist at Dezan Shira & Associates. “We can see that the draft will introduce a more complex approach to transfer pricing documentation and imposes higher requirements on documentation preparation. For multinational companies, the preciseness of international tax planning has become more enforced; thus, under some circumstances, companies might be forced to change their current business structure, related-party transaction arrangement and transfer pricing policies. Notably, the terms used in the draft are comparatively broad, which leaves room for how local tax authorities will enforce it in practice. So it is therefore difficult to say the exact extent to which the new regulations will have an impact on foreign companies operating in China.”
Asia Briefing Ltd. is a subsidiary of Dezan Shira & Associates. Dezan Shira is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in China, Hong Kong, India, Vietnam, Singapore and the rest of ASEAN. For further information, please email firstname.lastname@example.org or visit www.dezshira.com.
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