Businesses in China should comply with its latest transfer pricing documentation requirements to avoid penalties for non-compliance. Compared with the previous regime, key changes include:
- Annual Related Party Transactions Reporting Forms (the “New Forms”) replace the previous nine forms and increase the total number of forms from nine to 22. More detailed and transparent information disclosure is required. The New Forms also include the Country-by-Country reporting form (“CbC Form”).
- Bulletin on Improvements to Reporting of Related-party Transactions and Administration of Contemporaneous Documentation (SAT Bulletin  No. 42 or “Bulletin 42”) introduces a three-layer documentation approach, including master, local, and special issue files, compared with the old transfer pricing regime that did not involve the master and special issue files. In addition, the local file must now include a value chain analysis as well as location-specific advantages (“LSAs”).
Conditions that require preparation of a master file
An enterprise is required to prepare a master file for a fiscal year in Chinese if it meets any of the following thresholds:
- When the enterprise has cross-border related party transactions and its group has prepared a master file; or
- Related party transactions totalling over RMB1 billion during the year
Conditions that require preparation of a local file
An enterprise is required to prepare a local file for a fiscal year in Chinese if it meets any of the following thresholds:
- Transfer of over RMB200 million (for toll manufacturing, the amount in customs records for imports and exports should be included) in tangible assets;
- Transfer of over RMB100 million in financial assets;
- Transfer of over RMB100 million in intangible assets;
- Other related party transactions totalling over RMB40 million; or
- An enterprise that engages in simple manufacturing activities such as toll processing, contract manufacturing, simple distribution or contract R&D and incurs a loss is required to prepare a local file regardless of whether it reaches any of the thresholds listed above*.
*The last condition was not stated in Bulletin 42. Instead, it was specified in Bulletin of the State Administration of Taxation on Promulgation of the Administrative Regulation for Special Tax Audit Adjustment and Mutual Agreement Procedures (“Bulletin 6”).
Conditions that require preparation of a special issue file
An enterprise is required to prepare a special issue file in Chinese if it meets any of the following thresholds:
- The related party debt-to-equity ratio exceeds 2:1 for non-financial enterprises or 5:1 for financial enterprises; or
- Enterprise engaged in a cost-sharing agreement
Other considerations for documentation
Enterprises that have only conducted related party transactions with domestic related party companies, or implemented an Advance Pricing Arrangement (APA), are exempt from preparing master, local and special issue files.
Deadline for preparation
The master file shall be prepared within 12 months after the date when the group’s ultimate holding company’s fiscal year ends.
The local and special issue files shall be prepared before June 30 of the year following the year when the related party transaction occurred.
Deadline for submission
Contemporaneous documentation shall be provided within 30 days of the tax authority’s request.
|Content of master file
||Content of local file|
|Bulletin 42 states that the master file must disclose key global business information of the whole group to which the Chinese enterprise belongs, including the group’s organisational structure, the group’s business description (including intercompany transactions), intangibles, financing activities, as well as financial and tax status.
A chart illustrating the group’s global organisational structure, shareholding structure and geographical location of all business entities in the group
Group’s business description
A description of the group’s business, including the supply chain and geographical locations of major markets, important intragroup service arrangements, value-creating contributions from each entity, functional changes due to business restructuring, risks or assets within the group, and reorganisations during the fiscal year
• A description of overall strategies in relation to the development and utilisation of intangibles, determination of the ownership of intangibles, the group’s transfer pricing policies relating to R&D and intangibles, as well as any transfer of interests in intangibles among related parties during the fiscal year
• A list of intangibles of the group that have a significant impact on the group’s transfer pricing policy, the ownership of such intangibles, and significant intangibles-related agreements between entities in the group
A description of intragroup financing arrangements, the group’s key financing arrangements with unrelated parties, entities in the group that provide central financing for the group, as well as the group’s transfer pricing policies relating to financing arrangements between related parties
Financial and tax status
• The group’s annual consolidated financial statements for the latest fiscal year
• A list of the group’s existing unilateral APAs, bilateral APAs and other tax rulings relating to the allocation of income among countries, together with brief descriptions, names and locations of entities in the group that will prepare and submit the Country-by-Country report
|Bulletin 42 states that the local file should provide an overview of the Chinese enterprise, detailed information of its related party relationships and transactions, information on the selection and application of transfer pricing methods, as well as a comparability analysis.
Overview of Chinese enterprise
• Organisational structure;
• Management structure;
• Industry description;
• Business strategy;
• Financial data for each type of business and product; and
• A description of reorganisations or transfers of intangibles that involve or affect the Chinese enterprise, and how such changes affect it
Related party relationships
• Information on related parties;
• Information on income taxes that apply to related parties, including names of such taxes, tax rates and any preferential tax treatment; and
• Changes in related party relationships during the fiscal year
Related party transactions
• Overview of related party transactions;
• Analysis of value chain;
• Outbound investment;
• Related party equity transfer;
• Related party services; and
• APAs in foreign countries and tax rulings directly relating to the enterprise’s related party transactions
Selection and application of transfer pricing methods
• Selection of the tested party and rationale for the selection;
• Selection of transfer pricing method and rationale for the selection (regardless of the method selected, the enterprise must explain its contribution to the group’s overall profit or residual profit);
• Any assumptions and judgements made in the process of determining the arm’s length prices or profits;
• Application of reasonable transfer pricing methods and results of the comparability analysis to determine the arm’s length prices or profits;
• Other information to justify selection of the transfer pricing method; and
• Analysis and conclusion on whether the pricing policy of the related party transaction complied with the arm’s length principle
• Factors considered in performing the comparability analysis;
• Information on the functions performed, risks assumed and assets employed by comparable enterprises;
• Industry description;
• The search method, source, selection criteria and rationale for the comparable information;
• Information of selected internal or external comparable uncontrolled transactions and the financials of comparable enterprises; and
• Adjustments made to the comparable data and rationale for these adjustments
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