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Q: Why do foreign enterprises use transfer pricing?

    Foreign enterprises use transfer pricing for the purpose of profitability. Despite tax exemptions and other preferential policies on offer, some foreign businesses adopt low prices but report high prices when importing equipment, pass off inferior goods as quality goods and raise production costs thereby gaining big profits on equipment with unfair equity ratios. As a result, state-owned assets and income tax have been draining away.


    Increasing profits outside China – foreign businesses report high prices and charge high technology transfer fees and royalties for the purpose of transferring profits. In some FIEs that are controlled by foreign parties, the Chinese party follows protocols with the foreign party and relies on the foreign party to make decision on importing technology. The transfer of technology and exclusive rights, such as the transfer of trademarks is entirely controlled by the foreign party. Sometimes the foreign party does not make reasonable valuations and by this means of transfer pricing, it reduces it profits in China and increases its profits outside China.

Related FAQs From the topic Special tax adjustments

  • 1.What is transfer pricing?

    Transfer pricing is the pricing of goods, services and intangibles and the making of other payments between companies that are commonly owned or controlled across state and national boundaries.

  • 2.What are the Transfer Pricing rules in China?

    Transfer pricing in China is governed by the Income Tax Law, and The Law Concerning the Administration of Tax Collection.


    Furthermore, the State Administration of Taxation has issued a number of rulings on the issue. The most important one is Guoshuifa [2009] No.2.


    The Chinese government has also adopted international principles. Accordingly, inter-company transactions should be priced according to the “arm’s length principle”. If firms are regarded as associated, which they are if one of the entities are owned or controlled by another entity, then the assets must be priced according to the arm’s length transaction principles.

  • 3.Which methods are used to determine the pricing?

    There are 6 methods that are currently used to determine the pricing. These are:


    1. Comparable Uncontrolled Price Method


    A pricing method adopted by arm’s length parties in conducting same or similar transactions;


    2. Resale Price Method


    A product purchase pricing method that begins with the resale price to arm’s length parties (of a product purchased from an affiliated party), reduced by a gross margin of the same or similar transactions;


    3. Cost-Plus Method


    A pricing method that takes into consideration additional cost, reasonable fees and profits;


    4. Transactional Net Profit Method


    Profits are determined as per the net profit margins of arm’s length parties in conducting same or similar transactions.


    5. Profit Split Method


    The consolidated profits or losses of an enterprise and its affiliated parties are allocated between or among them using a reasonable rate.


    6. Other Methods


    As set out in compliance with the arm’s length principle.

  • 4.What is the current legislation governing business transactions between affiliates?

    Under the Law of the People’s Republic of China on Enterprise Income Tax promulgated in 2007 and Circular of the State Administration of Taxation on Printing and Distributing the Implementing Measures for Special Tax Adjustments (Guo Shui Fa [2009]No. 2, China adopts the internationally recognised “arm’s-length rule” for transfer pricing. Accordingly, a subsidiary in China should be pricing the goods it sells to its parent company at the same fair level as if the parent company was an unrelated party. Similarly, the parent company must charge interest and royalties to its subsidiaries at rates it would offer to non-affiliates.


    The Law of the People’s Republic of China on Enterprise Income Tax and its detailed implementing rules allow China’s tax authorities to make reasonable adjustments to prices and costs if they believe that a foreign enterprise has lightened its tax burden in China by failing to adhere to the arm’s-length rule. If the Chinese subsidiary can only provide its local SAT office with information which shows that it is selling its goods to the parent company at unjustifiably deflated prices, the SAT officials have the right to apply the “comparable uncontrolled” method, “resale price” method, “cost plus” method or any other reasonable method to adjust the prices to an arm’s-length standard for tax purposes. These methods will be familiar to companies whose business straddles two or more jurisdictions. The Chinese tax authorities may also effect appropriate adjustments to abnormally high or low interest rates or to non-existent or negligible royalty payments in affiliate transactions.

  • 5.What are the aspects of the framework for the administration system for the taxation of transfer pricing as stated in the Transfer Pricing Notice?

    The Transfer Pricing Notice lays down the framework for a highly efficient administration system for taxation of transfer pricing. The key elements include competent specialist audit teams to inspect the transfer pricing aspects of foreign enterprises’ transactions and a database for administration of transfer pricing using information gathered from other government authorities such as the respective Administration of Industry and Commerce, PRC customs authorities and banks. In addition, departments dedicated to the tax administration of transfer pricing will be established within tax authorities in areas where Foreign-Invested Enterprises (“FIEs”) are concentrated.

  • 6.What obligations are placed on FIEs by the Transfer Pricing Notice?

    China adopts stringent requirements on filing related party information. Tax payers are required to file annual related party transaction reports as part of their annual CIT filing package before May 31st of each year. In addition, enterprises are required to prepare TP documentation in place for inspection upon request by Chinese tax bureaus. Enterprises meeting certain conditions are exempt from such requirements.

  • 7.Do companies in China normally have Advanced Pricing Agreements (APA)?

    It depends on the complexity of explaining the manner in which a company does its pricing. If many complex issues are involved, then perhaps a company will need to have an APA in place. It also depends on the respective local tax authorities and their expertise in this area. If the local authorities are not well versed in this area (which undoubtedly is highly specialised), then it is futile investing time and effort to put together an APA.


    * (An APA is an agreement between the tax authorities and the taxpayer, setting out the method of transfer pricing policy for controlled transactions over a fixed period of time.)

  • 8.How long does it take for an APA to be approved in China? What needs to be done?

    At present, an APA between the taxpayer and the tax authority takes nine months to a year for approval in China. A pre-filing meeting with the State Tax Bureau is essential to discuss the following particulars:


    (i) Parties involved;


    (ii) Duration of the agreement;


    (iii) Documents for review by the State Tax Bureau;


    (iv) Any double taxation involved;


    (v) Sufficiency of documentation to make market price comparisons;


    (vi) Principles applicable in determining transfer pricing methods;


    (vii) Compliance requirement of the Tax Bureau.

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