Transfer Pricing and Foreign Currency Controls in China

Transfer Pricing and Foreign Currency Controls in China

Transfer pricing

Transfer pricing concerns the prices charged between associated enterprises established in different tax jurisdictions for their intercompany transactions.

The relationship threshold for transfer pricing rules to apply between parties is low compared to other countries. All transactions between the HQ and its China-side entity should be conducted based on the arm’s length principle, as the two are related parties according to Chinese tax laws. From a transfer pricing perspective, taxpayers operating in China have to be aware of their tax filing obligations.

This consists of two parts:

(a) Ensuring that related party transactions are appropriately disclosed in the tax return; and

(b) Preparing and maintaining detailed transfer pricing documentation, if required.

Related-party transaction reporting

When filing annual tax returns, all resident enterprises under the scheme of tax assessment by accounts inspection and non-resident enterprises establishing organizations or premises in China should submit the Enterprise Annual Reporting Forms for Related Party Transactions of the People’s Republic of China, which in total consists of 22 separate forms. Of the 22 forms, six are country-by-country reporting forms, which must be prepared bilingually, while the other 16 must be prepared in Chinese. These should be submitted in Chinese by May 31 of the following year (the same deadline as annual tax returns).

Contemporaneous documentation

In addition to filing the Related Party Transaction Forms, enterprises exceeding the relevant transaction threshold (except those that are covered by an advance pricing agreement or that only transact with domestic related parties) should prepare and maintain contemporaneous transfer pricing documentation before the stipulated deadlines, and in line with Chinese transfer pricing regulations.

Under the current transfer pricing regulation, a three-tiered contemporaneous documentation framework - master file, local file, and special file - is implemented in China. For easier understanding, we’ve summarized the three-tiered framework of contemporaneous documentation below.

Scope of Enterprises to Prepare Contemporaneous Documentation in China


Scope of enterprises


Master file

  • Enterprises that make cross-border related party transactions during the year and the ultimate holding company that consolidates the enterprise’s financial statements have prepared the master file; or
  • Enterprises with annual related party transactions that amount to RMB 1 billion (US$142 million) and above.

Within 12 months of the end of the fiscal year, the group’s ultimate holding company

Local file

  • Enterprises with annual related party transactions for transferring the ownership of tangible assets that exceed RMB 200 million (US$28 million);
  • Enterprises with annual related party transactions for the transfer of financial assets exceeding RMB 100 million (US$14 million);
  • Enterprises with annual related party transactions for the transfer of ownership of intangible assets that exceed RMB 100 million (US$14 million);
  • Enterprises with other types of related-party transactions that exceed RMB 40 million (US$5.7 million) in total; or
  • Single-function companies that incurred a loss should prepare the local file regardless of the annual related-party transaction amount, including both domestic and cross-border transactions.

Before June 30 of the year that follows the related party transaction

Special file

  • Enterprises entering cost-sharing arrangements with related parties; or
  • Enterprises need to state whether the arm’s length principle is complied with due to the related party debt-equity ratio exceeding the standards.

Before June 30 of the year that follows the related party transaction

China's foreign currency controls

China implements a strict system of capital controls, limiting the inflow and outflow of foreign currency. This system distinguishes between transactions made under an enterprise’s current account and capital account and requires foreign investors to open separate bank accounts for the two.

The State Administration of Foreign Exchange (SAFE) and its local branches are the bureaus in charge. The SAFE divides foreign currency transactions into two separate categories those under the current account and those under the capital account.

Current account foreign currency transactions may involve the import and export of goods and services, earnings from interest or dividends from portfolio securities, and regular transfers. Capital account transactions are mainly related to foreign direct investment (i.e., changes in a company’s registered capital), the purchase and sale of equity or debt securities, and trade credit or loans. Capital account transactions need approval from the SAFE, while current account transactions can be made directly through the bank.

Did You Know?
Currently, FIEs are allowed to convert up to 100 percent of foreign currency in their capital account into RMB at their own discretion.

SAFE reserves the right to regulate the percentage of foreign currency a company may have as part of its capital account. These fluctuate according to China’s Balance of Payments, which refers to transactions between the entities and individuals of two countries.

 The following income is allowed to be put in the capital account:

  • Foreign exchange capital transported from overseas or by foreign investors;
  • Foreign exchange capital for security deposits of overseas remittances;
  • RMB funds returned after legal transfers (or funds returned as a result of revoked transactions); and
  • Received interest income (must be approved by SAFE-certified bank).

The following usages are still strictly prohibited to justify the conversion of foreign exchange to RMB currency:

  • Expenditure beyond business scope or state laws/regulations, directly or indirectly;
  • Investing in securities or other financial products not secured by the bank, directly or indirectly (unless currently existing laws or regulations state otherwise);
  • RMB entrusted loans to non-related enterprises (unless included in the company’s business scope); and
  • Constructing or purchasing real estate not for the company’s use (unless the company deals in real estate as part of its business activities).

FAQ: How BEPS 2.0 is Reshaping the Global Tax Landscape for Multinational Enterprises in Asia

What are the BEPS 2.0 pillars?

The Base Erosion and Profit Shifting, commonly referred to as BEPS 2.0, aims to ensure a fairer distribution of taxing rights is established with respect to the profits of large multinational enterprises (MNEs) and to set a global minimum tax rate.

The BEPS 2.0 package consists of two parts, also called the two pillars:

  • Pillar One is focused on profit allocation and nexus; and
  • Pillar Two is focused on a global minimum tax.

Pillar One – profit allocation and nexus

The aim of Pillar One is to make MNE groups pay taxes in the countries where they have users, even if they have no commercial presence there.

Pillar One targets the largest and most profitable MNEs. According to the OECD’s statement, all MNE groups with global turnover above €20 billion and profitability above 10 percent (profit before tax) are targeted by Pillar One. (The threshold will be reduced to €10 billion after seven to eight years, contingent on successful implementation. Extractive industries and regulated financial services are excluded from the Pillar One scope).

The key elements of Pillar One can be grouped into two components: a new taxing right for market jurisdictions (where customers are based) over a share of residual profit calculated at an MNE group level (“Amount A”) and a fixed return for certain baseline routine marketing and distribution activities (“Amount B”).

The plan proposed that a certain portion (25 percent) of the residual profit (profit exceeding a 10 percent margin) of these MNEs should be taxed in the market jurisdictions.

It is estimated that Pillar One will impact 78 of the world’s 500 largest companies. Major international technology enterprises will account for around 45 percent – or US$39 billion – of the estimated total allocation of profits of US$87 billion (Amount A) that will be subject to scrutiny under Pillar One.

Pillar Two – global minimum taxation

Pillar Two sets a global minimum tax rate (15 percent) and targets large MNE groups with global turnover above €750 million.

Under Pillar Two, if an MNE group's jurisdictional effective tax rate is below the global minimum tax rate, its parent or subsidiary companies will be required to pay top-up tax in their jurisdictions to meet the shortfall.

Pillar Two consists of a series of Global Anti-Base Erosion (GloBE) rules, including:

  • An income inclusion rule (IIR), which would impose current taxation on the income of a foreign-controlled entity or foreign branch if that income was otherwise subject to an effective rate that is below a certain minimum rate;
  • An undertaxed payment rule (UTPR) would either deny a deduction or impose a possible withholding tax on base eroding payments unless that payment is subject to tax at or above a specified minimum rate in the recipient’s jurisdiction; and
  • A treaty-based rule, known as the subject-to-tax rule (STTR), ensures that treaty benefits for certain related-party payments (particularly interest and royalties) are granted only in circumstances where an item of income is subject to tax at a minimum rate in the recipient jurisdiction.

What is China’s exposure to the new international tax rules being written under BEPS 2.0?

Compared to other low-tax rate regions, China, with a national corporate income tax rate of 25 percent, is less exposed.

However, China does implement a wide range of tax incentives. For instance, some high-tech enterprises, enterprises engaged in encouraged industries in China’s western regions, as well as some enterprises registered in the Hainan Free Trade Port, may be able to enjoy an effective corporate income rate of lower than 15 percent.

Large MNEs from China need to measure the thresholds (their global turnover levels) at which the minimum tax rule is applied to assess whether they are within the scope.

Chinese technology titans, such as Alibaba and Tencent, which have divisions in the Cayman Islands, could also be hit by the two-pillar approach. MNEs should carefully review the principal design elements agreed to in the OECD statement to determine how the proposals would impact their businesses and multijurisdictional tax liabilities, including whether any sector-specific exemptions in one region could result in tax shortfall in terms of global tax liabilities.


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