Transfer pricing dispute resolution in China involves preventive, defensive, and remedial measures, from advance pricing arrangements and self-adjustment to audit defence and the Mutual Agreement Procedure. This article explains how engaging tax professionals early can help MNEs identify high-risk arrangements, strengthen documentation, engage with the Chinese tax authorities, and manage double taxation.
With contributions from Abby Yang, Tax Director, Transfer Pricing Service at Dezan Shira & Associates, and Xiaohan Xu, Senior Associate, Tax at Dezan Shira & Associates.
Transfer pricing disputes can quickly turn into costly and time-consuming processes for foreign multinational enterprises (MNEs) operating in China. Engaging a tax professional early can make these issues much easier to manage, helping MNEs identify risks, strengthen their transfer pricing documentation, and address disagreements before they escalate into lengthy disputes.
This is the second part of our series on transfer pricing disputes in China. Part I outlined the typical dispute scenarios, including location-specific advantages, intragroup service fees, loss-making manufacturers and distributors, and royalty payments.
In Part II, we look at how these disputes can be prevented and addressed, from advance pricing arrangements and self-adjustment to audit defence and double taxation relief, and discuss how professional advisers can help prevent and mitigate risks.
See Part I here: How Transfer Pricing Disputes Arise in China – A Guide for MNEs
How can tax professionals help prevent and address transfer pricing disputes?
From a practical perspective, transfer pricing disputes can be managed through a combination of preventive, defensive, and remedial measures. At the preventive stage, MNEs may consider an advance pricing arrangement (APA), particularly for material and recurring related-party transactions, to obtain greater certainty over the applicable transfer pricing methodology and reduce the likelihood of future disputes. Where potential transfer pricing exposure is identified, corrective measures, including voluntary adjustments where appropriate, may be considered before the matter develops into a formal investigation.
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We help companies assess intercompany arrangements for audit risk and prepare supporting documentation.Once an enquiry or investigation has commenced, the focus shifts to audit defence, including assessing the technical and economic basis of any proposed adjustment and substantiating the taxpayer’s position through appropriate factual, financial, and economic evidence. If an adjustment ultimately gives rise to double taxation, the taxpayer may consider corresponding relief or the Mutual Agreement Procedure (MAP) under the applicable tax treaty.
Engaging professionals early in the transfer pricing dispute process, regardless of whether it is the preventive, defensive, or remedial stage, can significantly reduce the risk of disputes arising in the first place, or prevent lengthy and costly legal and remediation procedures.
Identifying and assisting in high-risk arrangements
Engaging professionals early in the transfer pricing dispute process – or even before a dispute arises – is crucial in order to identify risks, ensure compliance with Chinese transfer pricing rules, and minimise the likelihood and costs of disputes.
Professional advisers can identify potential areas of disagreement before they escalate into investigations or adjustment decisions. Early advisory also allows MNEs to identify weaknesses and address potential disputes before the tax authorities challenge their arrangements.
As outlined in Part I of this series, the STA looks more closely at certain types of businesses and business arrangements. Companies that are in high-risk categories for tax investigations, such as loss-making manufacturers and distributors, or those making substantial royalty payments or intragroup service fee payments to overseas related parties, should consider engaging professionals early. These arrangements are more likely to attract scrutiny and may require additional documentation or adjustments to demonstrate compliance with the arm’s length principle.
Tax advisers can also help assess whether losses, royalty payments, or changes in business circumstances are adequately supported by the company’s transfer pricing policies and documentation, while identifying areas requiring further review or corrective action.
Advising on self-adjustment versus formal investigation pathways
Where a potential transfer pricing risk is identified, companies should consider whether it may be appropriate to address the issue proactively through a self-adjustment rather than allowing the matter to develop into a formal special tax investigation. While both routes may ultimately result in additional tax, they differ in terms of procedure, administrative involvement, certainty of outcome, and the availability of subsequent dispute resolution mechanisms. The key differences are summarised below.
| Item | Self-Adjustment | Case Initiation & Investigation |
|---|---|---|
| Competent tax authority | Local competent tax authority | Approval from provincial tax authorities or the STA is required for both case filing and case closure |
| No centralised management by STA required | Nationwide unified administration | |
| Retroactive adjustment period | Not exceeding 10 years | Usually 10 years |
| Investigation duration | Case-dependent, generally no more than 6 months | Usually 1 to 3 years |
| Certainty of adjustment outcome | Tax authorities may still conduct special tax investigation and adjustment in accordance with relevant provisions | Adjustment results are final/determinative |
| Whether MAP can be initiated | NA | MAP available |
| The counterparty to the related-party transaction may apply for tax refund in other contracting state | ||
| Additional interest and penalty interest |
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| Attitude of tax authorities | Relatively lenient | More stringent |
The comparison highlights the practical value of identifying transfer pricing issues at an early stage. A self-adjustment may provide an opportunity to address identified exposure before a formal investigation is initiated, although it does not prevent the tax authorities from subsequently conducting a special tax investigation. Once a formal investigation is initiated, the process becomes more procedurally structured and the focus generally shifts from proactive risk correction to audit defence and, where double taxation ultimately arises, potential dispute resolution mechanisms such as MAP.
Ensuring accurate and comprehensive documentation
Tax advisers can help companies prepare contemporaneous documentation that outlines the commercial rationale for certain financial arrangements or positions, including service or royalty fee payments, losses, and changes in functions, risks, assets, or economic circumstances. This is more effective if done early in the process, as it will enable better documentation of decisions, underlying assumptions, and changes in business, and can help to build a trove of evidence in the event of a dispute.
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Facing a transfer pricing audit or adjustment in China? We can help with audit defence, self-adjustment strategy, and APA or MAP support.Tax advisers also assist with conducting and assessing benchmarking studies in order to evidence the arm’s length principle in terms that align with the Chinese tax authorities’ own rules and expectations, and from that assess whether financial arrangements or profit margins are compliant or risk triggering scrutiny.
Where circumstances change, advisers can also help establish when the change occurred, how it affected the parties’ contributions or economic benefits, and whether the existing arrangements should have been revised.
Facilitating engagement with local tax authorities
Engaging a tax adviser early in the transfer pricing or dispute process can help to reduce misunderstandings and protracted dispute procedures with the Chinese tax authorities. Tax advisers in China are familiar with local Chinese tax authorities and how they administer transfer pricing rules and are therefore better able to communicate the Chinese tax authorities’ rationales and expectations to the MNE. This understanding can help the MNE, where possible, make necessary adjustments to current arrangements while ensuring accurate, comprehensive documentation to support a position that may attract scrutiny from the tax authorities.
Moreover, advisers can help MNEs navigate procedural requirements and respond to requests for information from the tax authorities, while also analysing and communicating the implications of different resolution options to the MNE.
Managing double taxation and navigating dispute resolution options
While engaging a tax adviser early in the process helps avoid and settle disputes, advisers can also outline the possible ramifications for the company when a Chinese tax adjustment increases taxable profits, including the risk of double taxation in the foreign jurisdiction.
If double taxation does indeed arise, the adviser can help to assess and pursue appropriate relief, whether through domestic remedies, the Mutual Agreement Procedure (MAP) under an applicable tax treaty, or other mechanisms. This also involves awareness of relevant deadlines, documentation requirements, and the interaction between Chinese proceedings and foreign tax procedures.
How Dezan Shira & Associates can help
Dezan Shira & Associates helps businesses navigate China’s transfer pricing rules, identify potential risks, and prepare robust documentation to support their intercompany arrangements. Our advisers also assist with tax audits, transfer pricing disputes, and resolution strategies to help mitigate the risk of costly adjustments and double taxation. Contact us today to discuss how we can support your business.
