"Merger & Acquisitions in China"
David S. Eberly
David S. Eberly
Global Sourcing Solutions
Sourcing automotive components in China
Need an office in China? Office suites, meeting rooms, virtual offices, network access
Need a cell phone for your trip to China?
Sourcing automotive components in China
Need an office in China? Office suites, meeting rooms, virtual offices, network access
Need a cell phone for your trip to China?
CHINA: "Encouraging a Sustainable Approach to China Sourcing"
From Short-Term Benefit to Long-Term Value: Encouraging a Sustainable Approach to China Sourcing. 8-page report by Deloitte.
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From Short-Term Benefit to Long-Term Value: Encouraging a Sustainable Approach to China Sourcing. 8-page report by Deloitte.
proceed to download
eJournals
2009 Global Transfer Pricing survey: China - survey findings
Resources the taxing authority is devoting to transfer pricing.
The Anti-Avoidance Division of the International Tax Department at the State Administration of Taxation (SAT) is responsible for the administration of transfer pricing issues in China. The anti-avoidance work, including the administration of contemporaneous documentation, is mostly carried out by all of the local tax bureaus.
The tax bureaus are increasing training for anti-avoidance tax professionals, including short-term training, medium- to long-term training, and domestic and overseas training. In addition, the tax bureaus will recruit university graduates with relevant degrees to join the anti-avoidance workforce. We understand that in the next three years, the SAT plans to establish an anti-avoidance team with several hundred professionals across China.
Further, the tax bureaus are strengthening information technology tools and databases to support anti-avoidance work.
Industry focus
The tax bureaus continue to focus on the apparel, electronics and telecommunications, food and beverage, retail, industrial, automotive, pharmaceuticals, and service industries, as well as on financing issues relating to infrastructure construction and on companies with outbound investments.
Geographic focus
The Administrative Measures of Special Tax Adjustments (Guoshuifa (2009) No. 2) provides for a focus on entities that have transactions with low-tax jurisdictions or tax havens.
Also, tax bureaus in the coastal provinces of China and the cities of Beijing and Shanghai have been active in conducting transfer pricing audits.
Types of transactions under scrutiny
We understand that royalties and fees for labor services are key transactions under review from the transfer pricing perspective in China.
In addition, the SAT objects to taxpayers who rely on the lower quartile of comparable ranges, especially those who rely on the lower quartile over a long period. The SAT used to accept the inter-quartile range assuming that companies’ profits should be evenly distributed — considering that some should achieve the upper quartile while some should achieve the lower quartile, or that an enterprise should have some years resulting near the upper quartile and years resulting near the lower quartile.
It has been observed by the SAT that the vast majority of companies have kept their profitability around the lower quartile year after year; thus, the SAT has found it necessary to focus on the median when evaluating a company’s profit levels over time. The objective is to promote a better balanced distribution of profits achieved by companies in China.
Transfer pricing penalties
There are two main aspects of transfer pricing penalties for noncompliance:
* Penalties under the Tax Collection and Administration Law (TCAL) and its detailed implementation regulations (TCALIR) apply to noncompliance with the transfer pricing provisions.
* Interest on additional taxes owed on account of a transfer pricing adjustments also applies, comprising two components:
* A base rate of interest equivalent to the Yuan Renminbi (RMB) lending rate of the People’s Bank of China on 31 December of the year that the tax was due, applicable to the whole period for which the tax was not paid
* An additional 5% penalty interest (although this penalty may be waived if the taxpayer can provide the contemporaneous documentation due, or, if the taxpayer is exempted from preparing contemporaneous documentation in accordance with Article 15 of Guoshuifa (2009) No. 2, it provides other relevant materials requested by the tax authorities)
In addition, the unfavorable consequences of noncompliance may include the following:
* The taxpayer may be treated as a key target for a transfer pricing inspection.
* The tax bureaus can exercise the right to deem an amount of taxable income for the taxpayer and compute the tax due in accordance with Article 44 of the Corporate Income Tax Law (CITL).
* Generally, any APA application made by the taxpayer is not accepted.
Audit triggers
Article 29 of Guoshuifa (2009) No. 2 outlines seven criteria used to determine targets for transfer pricing investigation. The three major audit triggers are:
* A failure by the taxpayer to meet disclosure and documentation requirements.
* The taxpayer has low profits or has losses.
* The taxpayer has a large volume or large value of transactions with companies located in tax havens.
In particular, the SAT concentrates on companies that, in addition to having low profits or losses, pay large amounts in royalties to overseas related parties or have a large percentage of their main business activities involving related-party transactions.
Indirect and customs tax
There is no formal interaction of transfer pricing with indirect taxes. However, Chapter 3 Article 15 of the Guoshuifa (2009) No. 2 evaluates the documentation threshold limit for toll manufacturers based on export and import values declared in their customs records.
Comparable data
The tax authority uses public information to the greatest extent possible, considering the company and subsequent negotiation procedures. Only in the absence of public information, or if the public information cannot provide a sound assessment of the related-party transactions, is nonpublic information be used. Nevertheless, the SAT will not commit to limiting comparisons to public information only.
According to Article 41 of Guoshuifa (2009) No. 2, if the profitability of an enterprise falls below the median of the inter-quartile range, the profits should, in principle, be adjusted to the median. However, the tax authority takes historic conditions into consideration. If, for example, the profits of an enterprise are higher than the median in one year but lower in another year, provided the profits are distributed normally, the SAT would accept a single year’s results being lower than the median. The SAT encourages companies to achieve a normal distribution of profit levels.
Article 38 of the Guoshuifa (2009) No. 2 requires specific approval from the SAT for performance of any working capital adjustment to comparables.
Transfer pricing methods
According to Article 111 of the CITLIR, the transfer pricing methods available to taxpayers include the CUP method, the RPM, the cost plus method, the TNMM, profit split methods and other appropriate methods that comply with the arm’s length principle.
The China transfer pricing regulatory framework does not state a preference for the selection of a specific transfer pricing method.
Advance Pricing Agreements (APAs)
Article 48 of Guoshuifa (2009) No. 2 states that APAs are generally available for companies that meet three criteria:
1. Their annual related-party transactions exceed RMB 40 million (inclusive).
2. They fulfil their obligation to report related-party transactions.
3. They prepare, maintain and provide contemporaneous documentation in accordance with the rules.
The threshold of RMB 40 million is not a strict rule, as a lower level of transactions, for example, RMB 30 million, may also qualify, depending on the circumstances. However, applications from companies that are not compliant with the documentation and annual reporting requirements are not accepted.
An APA covers the period of three to five years following the year of application. At the company’s discretion, the methodology agreed in the APA can be rolled back to prior years. Any additional tax payment as a result of the roll-back may not be viewed as special tax adjustment, and therefore, arguably, interest penalty may be avoided.
We understand that, in 2008, the SAT concluded a total of 2 bilateral APAs (there have been 3 in total since introduction of the APA program in China) and 5 unilateral APAs. At present, 15 bilateral APAs and 2 unilateral APAs are in the negotiation or review process.
Three APAs have been concluded with the United States, Japan and Korea.
Yield/performance of transfer pricing reviews
Although the method of performance measurement of transfer pricing reviews by the SAT is not clear, we understand that, over the years, the number of audit cases has been significantly reduced, while the amount of transfer pricing adjustments has increased materially. The SAT thus appears to have been focusing on the comprehensiveness and depth of audits rather than on the number of audit cases.
Transfer pricing disputes
We understand that, in 2008, the SAT concluded four bilateral agreements on corresponding adjustments through the MAP. At present, three corresponding transfer pricing adjustments are in the negotiation or review process.
In 2009, The SAT will continue its corresponding adjustment and/or bilateral APA negotiation efforts with competent tax authorities using the MAP provided in the relevant tax treaties. The SAT proposes to negotiate 32 different cases, including MAPs and APAs with competent tax authorities in Japan, Korea, the United States, Singapore and Denmark.
Current influences on transfer pricing
One of the SAT’s major tasks is to ensure national consistency in implementing Guoshuifa (2009) No. 2. The SAT monitors and manages anti-avoidance investigations throughout the country. Through monitoring and management systems, the SAT can promote strict enforcement of transfer pricing investigations and, in turn, promote consistent standards in conducting anti-avoidance investigations.
Intercompany transactions involving royalty payments and labor services continue to be areas of focus. Further, it is expected that greater emphasis will be placed on companies that constantly rely on the lower quartile of the arm’s length range to support their transfer pricing.
We also understand that, in 2009, the SAT plans to further strengthen its internal processes and teams in the areas of audits and anti-avoidance in general. Further expansion of detailed anti-avoidance investigations and of related knowledge management resources seems likely, together with augmentation of information collection and administration processes.
Source: Ernst & Young - GAI
backCHINAtalk January, 2010
2009 Global Transfer Pricing survey: China - survey findings
Resources the taxing authority is devoting to transfer pricing.
The Anti-Avoidance Division of the International Tax Department at the State Administration of Taxation (SAT) is responsible for the administration of transfer pricing issues in China. The anti-avoidance work, including the administration of contemporaneous documentation, is mostly carried out by all of the local tax bureaus.
The tax bureaus are increasing training for anti-avoidance tax professionals, including short-term training, medium- to long-term training, and domestic and overseas training. In addition, the tax bureaus will recruit university graduates with relevant degrees to join the anti-avoidance workforce. We understand that in the next three years, the SAT plans to establish an anti-avoidance team with several hundred professionals across China.
Further, the tax bureaus are strengthening information technology tools and databases to support anti-avoidance work.
Industry focus
The tax bureaus continue to focus on the apparel, electronics and telecommunications, food and beverage, retail, industrial, automotive, pharmaceuticals, and service industries, as well as on financing issues relating to infrastructure construction and on companies with outbound investments.
Geographic focus
The Administrative Measures of Special Tax Adjustments (Guoshuifa (2009) No. 2) provides for a focus on entities that have transactions with low-tax jurisdictions or tax havens.
Also, tax bureaus in the coastal provinces of China and the cities of Beijing and Shanghai have been active in conducting transfer pricing audits.
Types of transactions under scrutiny
We understand that royalties and fees for labor services are key transactions under review from the transfer pricing perspective in China.
In addition, the SAT objects to taxpayers who rely on the lower quartile of comparable ranges, especially those who rely on the lower quartile over a long period. The SAT used to accept the inter-quartile range assuming that companies’ profits should be evenly distributed — considering that some should achieve the upper quartile while some should achieve the lower quartile, or that an enterprise should have some years resulting near the upper quartile and years resulting near the lower quartile.
It has been observed by the SAT that the vast majority of companies have kept their profitability around the lower quartile year after year; thus, the SAT has found it necessary to focus on the median when evaluating a company’s profit levels over time. The objective is to promote a better balanced distribution of profits achieved by companies in China.
Transfer pricing penalties
There are two main aspects of transfer pricing penalties for noncompliance:
* Penalties under the Tax Collection and Administration Law (TCAL) and its detailed implementation regulations (TCALIR) apply to noncompliance with the transfer pricing provisions.
* Interest on additional taxes owed on account of a transfer pricing adjustments also applies, comprising two components:
* A base rate of interest equivalent to the Yuan Renminbi (RMB) lending rate of the People’s Bank of China on 31 December of the year that the tax was due, applicable to the whole period for which the tax was not paid
* An additional 5% penalty interest (although this penalty may be waived if the taxpayer can provide the contemporaneous documentation due, or, if the taxpayer is exempted from preparing contemporaneous documentation in accordance with Article 15 of Guoshuifa (2009) No. 2, it provides other relevant materials requested by the tax authorities)
In addition, the unfavorable consequences of noncompliance may include the following:
* The taxpayer may be treated as a key target for a transfer pricing inspection.
* The tax bureaus can exercise the right to deem an amount of taxable income for the taxpayer and compute the tax due in accordance with Article 44 of the Corporate Income Tax Law (CITL).
* Generally, any APA application made by the taxpayer is not accepted.
Audit triggers
Article 29 of Guoshuifa (2009) No. 2 outlines seven criteria used to determine targets for transfer pricing investigation. The three major audit triggers are:
* A failure by the taxpayer to meet disclosure and documentation requirements.
* The taxpayer has low profits or has losses.
* The taxpayer has a large volume or large value of transactions with companies located in tax havens.
In particular, the SAT concentrates on companies that, in addition to having low profits or losses, pay large amounts in royalties to overseas related parties or have a large percentage of their main business activities involving related-party transactions.
Indirect and customs tax
There is no formal interaction of transfer pricing with indirect taxes. However, Chapter 3 Article 15 of the Guoshuifa (2009) No. 2 evaluates the documentation threshold limit for toll manufacturers based on export and import values declared in their customs records.
Comparable data
The tax authority uses public information to the greatest extent possible, considering the company and subsequent negotiation procedures. Only in the absence of public information, or if the public information cannot provide a sound assessment of the related-party transactions, is nonpublic information be used. Nevertheless, the SAT will not commit to limiting comparisons to public information only.
According to Article 41 of Guoshuifa (2009) No. 2, if the profitability of an enterprise falls below the median of the inter-quartile range, the profits should, in principle, be adjusted to the median. However, the tax authority takes historic conditions into consideration. If, for example, the profits of an enterprise are higher than the median in one year but lower in another year, provided the profits are distributed normally, the SAT would accept a single year’s results being lower than the median. The SAT encourages companies to achieve a normal distribution of profit levels.
Article 38 of the Guoshuifa (2009) No. 2 requires specific approval from the SAT for performance of any working capital adjustment to comparables.
Transfer pricing methods
According to Article 111 of the CITLIR, the transfer pricing methods available to taxpayers include the CUP method, the RPM, the cost plus method, the TNMM, profit split methods and other appropriate methods that comply with the arm’s length principle.
The China transfer pricing regulatory framework does not state a preference for the selection of a specific transfer pricing method.
Advance Pricing Agreements (APAs)
Article 48 of Guoshuifa (2009) No. 2 states that APAs are generally available for companies that meet three criteria:
1. Their annual related-party transactions exceed RMB 40 million (inclusive).
2. They fulfil their obligation to report related-party transactions.
3. They prepare, maintain and provide contemporaneous documentation in accordance with the rules.
The threshold of RMB 40 million is not a strict rule, as a lower level of transactions, for example, RMB 30 million, may also qualify, depending on the circumstances. However, applications from companies that are not compliant with the documentation and annual reporting requirements are not accepted.
An APA covers the period of three to five years following the year of application. At the company’s discretion, the methodology agreed in the APA can be rolled back to prior years. Any additional tax payment as a result of the roll-back may not be viewed as special tax adjustment, and therefore, arguably, interest penalty may be avoided.
We understand that, in 2008, the SAT concluded a total of 2 bilateral APAs (there have been 3 in total since introduction of the APA program in China) and 5 unilateral APAs. At present, 15 bilateral APAs and 2 unilateral APAs are in the negotiation or review process.
Three APAs have been concluded with the United States, Japan and Korea.
Yield/performance of transfer pricing reviews
Although the method of performance measurement of transfer pricing reviews by the SAT is not clear, we understand that, over the years, the number of audit cases has been significantly reduced, while the amount of transfer pricing adjustments has increased materially. The SAT thus appears to have been focusing on the comprehensiveness and depth of audits rather than on the number of audit cases.
Transfer pricing disputes
We understand that, in 2008, the SAT concluded four bilateral agreements on corresponding adjustments through the MAP. At present, three corresponding transfer pricing adjustments are in the negotiation or review process.
In 2009, The SAT will continue its corresponding adjustment and/or bilateral APA negotiation efforts with competent tax authorities using the MAP provided in the relevant tax treaties. The SAT proposes to negotiate 32 different cases, including MAPs and APAs with competent tax authorities in Japan, Korea, the United States, Singapore and Denmark.
Current influences on transfer pricing
One of the SAT’s major tasks is to ensure national consistency in implementing Guoshuifa (2009) No. 2. The SAT monitors and manages anti-avoidance investigations throughout the country. Through monitoring and management systems, the SAT can promote strict enforcement of transfer pricing investigations and, in turn, promote consistent standards in conducting anti-avoidance investigations.
Intercompany transactions involving royalty payments and labor services continue to be areas of focus. Further, it is expected that greater emphasis will be placed on companies that constantly rely on the lower quartile of the arm’s length range to support their transfer pricing.
We also understand that, in 2009, the SAT plans to further strengthen its internal processes and teams in the areas of audits and anti-avoidance in general. Further expansion of detailed anti-avoidance investigations and of related knowledge management resources seems likely, together with augmentation of information collection and administration processes.
Source: Ernst & Young - GAI
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