China Moves to Curb Transfer Pricing – Effective Immediately

Posted by Reading Time: 5 minutes

Contemporaneous-Transfer-Pricing-Documentation

By Dezan Shira & Associates

Legal Editor: Steven Elsinga

China tax authority, the State Administration of Taxation (SAT) issued an announcement on March 18, in which it outlines a number of transfer pricing transactions which would no longer be eligible for tax deductions. The decision is effective immediately.

The move follows an investigation into transfer pricing that first started in July 2014. The SAT requested local bureaus to gather information on the practice of transfer pricing for the purpose of launching a new policy. With the release of these new guidelines, tighter scrutiny of multinational companies is expected.

The new policy aims specifically to exclude service payments to overseas related entities for functions that aren’t actually performed, the bearing of risk, or business activities that are not in fact carried out by the overseas entity. Even prior to the release of the new policy, Chinese tax authorities have been paying close attention to large payments to related entities in low-tax jurisdictions. In practice, corporate groups often set up entities in low tax jurisdictions specifically for the purpose of decreasing tax, while no business activity in fact takes place there. These transactions are now no longer deductible.

Richard Cant, Dezan Shira & Associates North American Regional Director, comments, “This is yet another attack by the Chinese revenue authorities on the perceived ‘transfer pricing’ by foreign groups operating in China by inter group service & royalty arrangements. It appears the onus is on the taxpayer to ensure that payments to offshore group companies are not covered by the new provisions. Having regard to the recent ‘heavy hand’ of the tax authorities in such TP matters, we predict that this will become another tough area for foreigners operating in China in 2015 and beyond.”

Related Link IconRELATED: China’s Transfer Pricing Obligations

Services rendered to the China-based entity by the overseas related party must enable the China-based entity to directly or indirectly gain economic benefit. If this is not the case, these expenses may not be deducted.

Specifically, these include:

  1. Services irrelevant to the operations of the company
  2. Services such as control, management or supervision that are rendered for the purpose of protecting the interests of the company’s shareholders. As the China-based entity is not the beneficiary of these services, these transactions do not comply with the arm’s length principle and are therefore not deductible.
  3. Services provided by the related party, that the China-based entity has already bought from another party or has performed itself.
  4. Services by the related party that have already been paid for in previous affiliated transactions.
  5. Benefits that the China-based entity enjoins as a consequence of being part of a group of companies, but that does not constitute a service rendered by the overseas entity. An example would be that the China-based entity is able to secure better terms for financing by virtue of it being part of a larger group of companies, which would increase the lender’s confidence.
  6. Other services that do not provide the China-based entity with any economic benefit. 

In addition, the new policy sets rules for the deduction of royalties payments to related parties. When a China-based company intends to make royalties payments to a related party, it needs to ascertain to which degree that related entity has contributed in the creation of that intangible asset. If the related entity only holds the property rights to the intangible asset, but did not play a role in its creation, the royalties payment will not comply with the arm’s length principle. Therefore, these payments will not be deductible. Instead, the China-based entity needs to pay the related parties that were involved in the creation of the intangible asset, to the degree that these parties contributed to the intangible asset.

One way to reduce tax is for a group of companies to set up an entity in a jurisdiction with little to no tax on royalties. The group then transfers all the royalties to that entity. This entity charges the group companies for the use of royalties, for which the entity will then pay little to no taxes. The stipulation described above intends to curb this practice.


About
Us

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 china@dezshira.com or visit www.dezshira.com.

Stay up to date with the latest business and investment trends in Asia by subscribing to our complimentary update service featuring news, commentary and regulatory insight.

 ‍

Related Reading

Transfer Pricing in China 2016Transfer Pricing in China 2016
Transfer Pricing in China 2016, written by Sowmya Varadharajan in collaboration with Dezan Shira & Associates and Asia Briefing, explains how transfer pricing functions in China. It examines the various transfer pricing methods that are available to foreign companies operating in the country, highlights key compliance issues, and details transfer pricing problems that arise from intercompany services, intercompany royalties and intercompany financing.

Annual_Audit_and_Compliance_in_China_2016Annual Audit and Compliance in China 2016
In this issue of China Briefing, we provide a comprehensive analysis of the various annual compliance procedures that foreign invested enterprises in China will have to follow, including wholly-foreign owned enterprises, joint ventures, foreign-invested commercial enterprises, and representative offices. We include a step-by-step guide to these procedures, list out the annual compliance timeline, detail the latest changes to China’s standards, and finally explain why China’s audit should be started as early as possible.

CB 2015 2 issue cover 90x126

Managing Your Accounting and Bookkeeping in China
In this issue of China Briefing, we discuss the difference between the International Financial Reporting Standards, and the accounting standards mandated by China’s Ministry of Finance. We also pay special attention to the role of foreign currency in accounting, both in remitting funds, and conversion. In an interview with Jenny Liao, Dezan Shira & Associates’ Senior Manager of Corporate Accounting Services in Shanghai, we outline some of the pros and cons of outsourcing one’s accounting function.

Leave a Reply

Your email address will not be published. Required fields are marked *