The China Resource Network and LehmanBrown International Accountants worked together to discuss challenges that businesses operating in and with China face when conducting related party’s business and setting the correct intercompany pricing methodology that could be acceptable to two different tax jurisdictions. The host was Kimberly Kirkendall, CEO of China Resources Network, and guest speaker Russell Brown OBE the Managing Partner of LehmanBrown.

The presentation was recorded and turned into a podcast which can be listened to here or on LehmanBrown’s official Google Podcast Channel.

Russell began by explaining that transfer pricing is all about balancing the price across multiple countries to find a reasonable position of equilibrium, not to raise suspicion of profit shifting or favouring tax in one jurisdiction over the other. Additionally, to not raise any suspicion of malpractice.

When reviewing pricing, one has to start by reviewing the companies’ operations, analyse internal and external risks, establish a defence in case the tax bureau investigates and finally check for any double tax agreements.

Depending on the industry, it is very likely that the tax authorities in China will not know precisely how one’s business is operated; thus, it is a matter of providing sufficient information to educate the tax bureaux sufficiently for them to undertake a review. Additionally, as they will often make comparisons with other similar companies, companies need to do a comparative analysis to test that their pricing methodology and margins align with industry medians.

In China, if a company has intercompany transactions of more than RMB40 million for passive income or more than RMB200 million for products, then an annual Transfer Pricing Report needs to be filed annually. If lower, whilst a company does not need to file this, there is a requirement to document related party transactions in their audit report and in their annual corporate income tax filing. As such, it is always advisable for companies to have some support for their practices.

A transfer pricing review should use a mixture of qualitative and quantitative data to defend any checking by the Tax Authorities. The qualitative reviews and describes the business, industry economy and functions and risks undertaken by both related parties, and quantitative analysis, which analyses the margins of the China business in comparison with comparables.

If the tax bureau were to undertake a review, they generally provide between 7 and 60 days for the company to respond. If a company has not prepared any documentation, then this does not provide much time if the checking is going back a few years. It is also important that a company take a cooperative stance during any tax bureau investigation and to try and understand the cause, whether random, an outlier with margins, a whistle-blower etc. The goal is always to bring such to a close as soon as possible.

China’s Tax Bureaux has a vast amount of data and may investigate because they have compared the company with other companies in a similar industry, but they could be very different in size and, importantly, have differently priced products or not similar products. In those situations, it’s fine to explain that the comparison is not comparable as long as the organisation does have a transfer pricing report with alternative companies that are more suitable to compare with.

Importantly, an investigation can go back three years or, in the worst case, ten years or even further, depending on the findings and nature of the investigation. Therefore it is recommended that Transfer Pricing Reports are updated every year to prepare for such a  scenario.

Due to the global pandemic, governments worldwide, including China, are taking a closer look at transfer pricing policies. There is also a worldwide movement towards a minimum tax rate for MNCs and how to deal with e-commerce businesses.  Having a proper review in place is the best defence against any tax review in any country.

Targets can also be businesses that have related parties in offshore low tax or no tax jurisdictions, where a business will then have to provide a valid defence that this entity is offering a vital function to the company’s overall operations and has substance, i.e. people, office etc.

In closing, both Russell and Kimberly agreed that transfer pricing is not a regulation; it is not science outside of the pricing methodology, but a very sophisticated tool that can be used to the business’s advantage and more like an art form it is about finding a balance between two jurisdictions taking into account their own regulations and the business functions and operations. Russell further advised all businesses that it is better to be prepared than be caught unprepared in such current times.

How can LehmanBrown Help?

Building on what Russell and Kimberly discussed, having a Transfer Pricing report is better than not having one, even if it just collects dust and gets reviewed once a year. LehmanBrown has been assisting various companies in China dealing with Tax Bureaux reviews or investigations, and the best advice is to keep calm, be as polite as possible, remember they are simply doing their job and that if your practices are well thought out and reasonable, any review can normally be closed off quickly.

To prepare for the possibility of a Tax Bureaux review or investigation and find out how long it would take to set up a Transfer Pricing report, feel free to contact our experts via email enquiries@lehmanbrown.com.

Alternatively, to stay informed of the latest China-related insights and tips, sign up for the LehmanBrown newsletter by emailing newsletter@lehmanbrown.com.