Given the enhancements to tax administration in China, transfer pricing (TP) has always been one of the areas of focus in recent years. With regard to TP audit and inspection practices, we highlight below several trends for the attention of multinational companies with investments in China.
1. Continuous enhancement of TP audits
The Chinese tax authorities continuously strengthen their investigation into companies with high value related party transactions or with multiple types of related party transactions, long-term losses, marginal or fluctuating profit, profit levels below the industry norm; and so on.
In particular, companies with significant cross-border service fees/royalty payments would be more likely to be selected by the tax authorities as an audit target, especially if the companies earn marginal profits or incur losses. The Chinese tax authorities nowadays view cross-border service fees/royalty remittances as a measure to shift profits out of China, and are therefore strengthening their administration and investigations into these activities.
2. Self-adjustment
With the utilisation of extensive data and new technology, the Chinese tax authorities tend to urge certain companies to conduct self-examination and self-adjustment if the tax authorities lack resources to initiate formal TP audits for these companies.
The tax authorities developed and launched a comprehensive electronic tax reporting system, through which all the financial data and tax filing information are centrally reported and disclosed to the tax authorities. In this way, the tax authorities have easy and full access to the taxpayers’ profitability, tax information and related accounting data, and are thus able to easily pick up suspicious companies from the electronic system and require these companies to carry out self-adjustment.
We have recently seen more and more companies being required to carry out the self-examination and self-adjustment procedure.
1. Continuous enhancement of TP audits
Multinational companies may face greater pressure and risk of a TP audit in China, and it would be more difficult for them to shift profits out of China through TP arrangements without proper TP planning and implementation.
Companies subject to a TP audit face a considerable tax adjustment amount, with consequent financial loss, and may also lose their credibility with the tax authorities in China, and would likely be under closer monitoring by the tax authorities in the follow-up supervision period.
Furthermore, these TP audits would have an impact on customs duties and import value-added tax (VAT), in addition to corporate income tax, especially when these companies import significant amounts from overseas related party companies. Such companies may consider communicating with the customs authorities after the TP audit is concluded, to seek any possible price adjustment for customs purpose.
2. Self-adjustment
Although the self-examination and self-adjustment is not a formal TP audit, the TP methodologies applied would not be far different from those applied in a formal TP audit. The TP analysis and adjustment scenarios proposed by taxpayers should rely on professional judgement.
Moreover, the self-examination and self-adjustment procedure would still involve intensive communication and negotiation with the tax authorities. The tax authorities would normally raise questions, review the self-examination and self-adjustment amount proposed by the taxpayers, and give their opinion or propose different adjustment approaches. The self-adjustment cannot be concluded without consent from the tax authorities.
If the relevant tax bureau and taxpayers are not able to reach agreement on the adjustment scenarios, or if the tax bureau identifies additional significant TP issues during the self-examination and self-adjustment process, the bureau may even report this case to a higher level tax bureau to initiate a formal TP audit.
1. Continuous enhancement of TP audits
In order to reduce the potential TP audit risk, multinational companies should design proper TP policies and take case with TP implementation during the operation of the business. In the event of of an inspection by tax authorities, companies should seek smooth and skilful communication with the tax authorities.
A particular point in China is that although the TP rules apply to the whole nation, the interpretation by tax officers in different parts of China of certain clauses in the rules could differ. Practical views and technical treatment of the same TP issue by tax bureaus in different jurisdictions of China may also differ.
Hence, communication with the tax authorities will play an essential role throughout the TP audit process. Companies should engage a reliable local tax adviser who can help with all risk management and communication with the tax authorities.
2. Self-adjustment
In the context of the increased TP administration of self-adjustment, companies should carefully review their TP arrangements and prepare robust supporting documents in order to minimise their potential TP risk in China. Meanwhile, companies should maintain a good relationship and seek smooth communications with the tax authorities.
BDO in China is experienced in all kinds of TP analysis as well as TP audit defence. We will be happy to support companies in establishing proper TP policies, preparing robust TP analysis supporting documents, and assisting with communications with tax authorities in China. Please do not hesitate to contact us for any such assistance.
Gordon Gao
gordon.g@bdo.com.cn
Emily Li
emily.li@bdo.com.cn