Transfer pricing involves setting prices for transactions between related companies and is closely monitored in China to prevent tax avoidance. China’s regulations, aligned with international standards, require transactions to follow the arm’s length principle.
This article provides a brief overview of China’s transfer pricing rules, essential compliance requirements, and strategies for minimising risks and penalties. Businesses must understand and adhere to these regulations to ensure smooth operations and avoid financial penalties.
Key takeaways
- All related-party transactions in China must follow the arm’s length principle, with contemporaneous documentation ready by 30 June following the relevant tax year.
- Chinese tax authorities may claim a larger share of group profits based on location savings, market premium and local intangibles, so benchmarking analysis should account for these factors.
- An Advance Pricing Agreement is one of the most effective ways to reduce audit exposure before scrutiny arises.
- Companies should assess annually whether their related-party transaction volumes trigger the thresholds for a master file, local file or special issue file.
- Transfer pricing is an estimation rather than an exact science, so a well-defined methodology and clear audit trail are the strongest defences against an investigation.
What is transfer pricing?
Transfer pricing, the practice of setting prices for transactions between related companies, is inherently complex. Several factors influence these prices, making establishing a single, universally accepted method difficult. This complexity attracts the attention of tax authorities, particularly China’s tax bureau, which has intensified its scrutiny in recent years.
Traditionally, transfer pricing involves companies in high-tax countries strategically lowering the price of goods, services, or intangible assets sold to affiliates in low-tax countries. Conversely, companies in low-tax countries inflate prices when selling to affiliates in high-tax jurisdictions. This strategy shifts profits from high-tax environments to low-tax ones, minimising the overall tax burden.
Overview of transfer pricing regulations in China
Transfer pricing in China is governed by Article 13 of the Income Tax Law for Foreign Investment Enterprises and Foreign Enterprises and Article 24 of the Law Concerning the Administration of Tax Collection. This legislation was first introduced in 1991 when China attempted to attract as many Foreign-Invested Enterprises (FIE) as possible. The regulations have been further tightened through the SAT, which issued a series of rulings (Guoshuifa).
Through these regulations, the PRC government has adopted international practices to govern transfer pricing based on comparable uncontrolled transaction principles, such as the OECD and US methodologies. The OECD Transfer Pricing Guidelines provide the international baseline from which China’s rules are adapted. Using these as guides, Chinese regulations stipulate that inter-company transactions and transactions between ‘associated entities’ should be priced using arm’s length principles.
