On 17 September 2015, China’s State Administration of Taxation released a consultation draft circular concerning implementation measures for special tax adjustments that would replace the existing Guoshuifa [2009] No. 2 (Circular 2). Now the SAT is seeking public comments on the consultation draft (Implementation Measures on Special Tax Adjustments) within 16 October 2015. Circular 2 contains the main body of rules governing transfer pricing in China and also covers other areas such as thin capitalization, controlled foreign corporations and the general anti-avoidance rule (GAAR).
The consultation draft fully embraces the internationally accepted arm’s length principle and, in many instances, closely mirrors guidance issued in the course of the G20/OECD Base Erosion and Profit Shifting (BEPS) project. To be sure, there are still many aspects of the consultation draft that have a distinctly Chinese flavor, such as the strong views on location savings, market premium and other location specific advantages (LSAs). The divergences from BEPS guidance are as telling as the areas of consistency.
The consultation draft would bring many changes to the transfer pricing framework established by Circular 2 including: documentation requirements, intra-group services, intangibles transactions, transfer pricing methods, and advance pricing agreements (APAs).
Transfer pricing rule: China’s State Administration of Taxation (SAT) issued a new draft implementation rules on 17 September 2015. If enacted, it will replace Cai Shui Fa [2009] No. 2.
Definition of control: The definition of related parties to which transfer pricing rules apply has been clarified and expanded in new draft implementation rules. Companies owned by family members who are related by up to three generations of kinship will also be treated as related party.
Intra-group services: The new consultation draft issued on 17 September 2015 by China’s State Administration of Taxation (SAT) introduced an entirely new requirement for the preparation of a Special File wherever a taxpayer engages in intra-group service transactions. The Special File would contain copies of the relevant intercompany agreements, documentation of service cost identification and allocation keys.
Financial services: A Special Report is required demonstrating that the taxpayer’s related party debt levels are consistent with the arm’s length principle if its debt to equity ratio exceeds specified ratios.
Transfer pricing methods: The consultation draft issued on 17 September 2015 describes two types of “other methods” that can be applied like the value contribution allocation method (VCM) and asset valuation method.
Cost contribution arrangements: As per the new consultation draft; SAT pre-approval is no longer required for taxpayers to enter into CSAs. There will be more emphasis on review and examination of all CSAs. The consultation draft continues to require that the parties adjust cost shares for differences between actual results and reasonably expected benefits, contrary to OECD guidance; although it can reasonably be inferred that only “significant” differences require adjustment.
Intangible property: The consultation draft has included an entirely new chapter concerning intangible property transactions.
Corresponding adjustment: The new consultation draft adds a provision requiring taxpayers to reconcile accounts after a transfer pricing adjustment has been made. If no corresponding adjustment is made, the taxpayer will be treated as having made a dividend distribution to its foreign counterparty.
BEPS related compliance:
Master file and local file: The new consultation draft issued on 17 September 2015 has included BEPS Action 13’s threefold approach to documentation, comprising the master file and local file.
CbC reporting requirement: As per The new consultation draft, Chinese-parented multinational groups that have global revenues greater than 5 billion RMB are required to submit a CBC Report with their annual tax return.
