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China: China in the changing international landscape of TP

Cheng Chi, Kelly Liao, Brett Norwood and Irene Yan of KPMG China explore recent developments to which taxpayers in China may want to pay special attention.

In recent years, the Chinese tax authority has repeatedly raised issues it feels have not been adequately addressed by the OECD Transfer Pricing Guidelines. It has suggested that greater attention should be given to problems and issues encountered by developing countries, emphasising practical solutions. Multinational enterprises (MNEs) operating in China may want to increasingly take into account transfer pricing issues China and other developing countries indicate are particularly important.

Transfer pricing and developing countries

With respect to base erosion and profit shifting (BEPS), action items 8, 9 and 10 of the BEPS Action Plan aim to ensure that transfer pricing outcomes are in line with value creation. This is broadly consistent with opinions expressed by the Chinese tax authority in the United Nations Practical Manual on Transfer Pricing, Chapter 10.3 China Country Practice (UN TP Manual CCP) and elsewhere, which lay out some of the issues of particular interest to the Chinese tax authority.

The BEPS Action Plan emphasises that the pricing of intangibles for transfer pricing purposes should be consistent with the value created by the intangibles. This idea is universally applicable regardless of a country's development stage. Of particular relevance, though, is that the marketing activities of many companies operating in China may be viewed as creating market-based intangible assets, distinct from those pre-existing in other jurisdictions, and should be allocated a level of profit consistent with their value.

The BEPS Action Plan also suggests that specific rules should be adopted to ensure returns are not allocated to an entity solely because it provides capital or contractually assumes risks. Some observers have noted that this may be inconsistent with the arm's-length principle, as there are a number of instances where a third party is awarded returns primarily because of supplying capital or assuming risk. Nonetheless, based on our experience the Chinese tax authority also emphasises an alignment of employee activities with profit allocation, and companies characterised as performing limited functions and assuming risks (especially in the sense of Guoshuihan No. 363 [2009]) should particularly note that if a profit ceiling is set in accordance with a limited risk profile, then a (positive) profit floor may also be determined.

In addition, expanding on the alignment of transfer pricing outcomes with value creation, as indicated by the Chinese tax authority in the UN TP Manual CCP, location specific advantages are also identified as a potential profit driver. MNEs sometimes achieve savings on raw materials, labour force and rent expenses in some jurisdictions. Because of the still-maturing nature of the Chinese market, limited market competition and strong purchasing power of some Chinese consumers, cost savings, and market premiums reflected in higher prices or demand quantities, may be regarded as profits created from location specific advantages and, therefore, should be taxed in China.

Focusing on the value chain

Action item 13 of the BEPS Action Plan proposes to re-examine transfer pricing documentation rules, including requiring MNEs to provide all relevant government bodies with specific information in a uniformed template disclosing their global allocation of income, economic activities and taxes paid in each country. On January 30 2014, to gather comments, the OECD issued a discussion paper on transfer pricing documentation and country-by-country reporting, including a revised draft guideline. This initiative will expand the information disclosure obligation of MNEs from focusing on a specific part of a value chain in one country to focusing on the entire value chain of the world wide group. This is of particular importance for taxpayers in China, where contemporaneous documentation requirements have been in effect since January 1 2008 (see Circular 2), and documentation reports are already widely collected, reviewed and graded throughout the country on an annual basis; and in practice, we do find that China tax officials already focus on value creation in controversy and advance pricing agreements (APA) discussions with individual taxpayers.

More publicly, in the UN TP Manual CCP the Chinese tax authority indicates that it is essential to understand the contribution of companies operating in China within a group's global value chain. Guoshuifa No. 2 [2009] Implementation Measures of Special Tax Adjustments (Provisional) ("Circular 2") Article 14 also states that contemporaneous documentation should disclose many specific details, including "taxes of income tax nature, the rates and tax incentives applicable" as well as "legal representatives, senior management, such as board members or managers" and other relevant information on related parties. If the country-by-country requirements laid out in the BEPS Action Plan are adopted, more information will be available to tax officials. As a result, the Chinese tax authority could more easily analyse the contributions, profit allocation and tax burden of companies operating in China within the global value chain. In addition, the availability of such information potentially allows for broader applications of profit split methods, which the Chinese tax authority could use as an alternative method to the transactional net margin method (TNMM), which we find the Chinese tax authority sometimes believes undervalues the contribution of the Chinese entity.

Intra-group service fees under scrutiny

Many MNEs charge intra-group service fees to affiliates for supporting services (for example finance, HR, IT) rendered by global and/or regional headquarters, or by shared service centers. However, the Chinese tax authority remains committed to protecting its tax base from inappropriate charge-out costs. Similarly, action item 10 of the BEPS Action Plan aims to, among other things, develop rules "protecting against payment such as management fees and head office expenses". Consistent with the concerns of the tax authorities of many other countries, especially those of developing countries, China's State Administration of Taxation (SAT) may increase scrutiny on outbound service fee payments. Based on our experience, as well as public speeches made by senior tax officials at the SAT, costs allocated to Chinese affiliates in connection with supporting services may be considered shareholder costs, and may be treated as non-deductible to the extent they do not add value to Chinese affiliates. We expect that scrutiny in this regard will continue to be particularly vigilant. Taxpayers should ensure that supporting services provide actual benefits to Chinese affiliates, use appropriate transfer pricing methods to determine the service fee amounts, and maintain sufficient documentation, to minimise deductibility issues in China.

Nonetheless, some relief was provided regarding remittance this year in terms of Announcement No. 40 [2013], jointly issued by the SAT and the State Administration of Foreign Exchange (SAFE) in July 2013. It converts the advance tax clearance system into a tax recordal filing system, with the effect to simplify and expedite outbound remittance for items such as service fees. Though this announcement is consistent with the general trend to gradually relax China's foreign exchange controls, the Chinese tax authority still reserves the right to conduct post-remittance examinations, which may lead to penalties and late payment surcharges if additional tax assessments are made. Also, it may take a period of time before the practices outlined in this announcement are completely implemented in all localities.

Tax controversy going forward

Action Items 5 and 6 of the BEPS Action Plan together propose to address harmful tax practices and improve the transparency and substance of transfer pricing arrangements, and to prevent treat abuse, respectively. As touched on above, we expect that increased transparency will allow the Chinese tax authority to more easily identify potential audit targets, have more information to make use of during audits, and even allow for the use of methods other than the TNMM, such as the profit split method, to be utilised more often. In addition, taxpayers should be aware that China's general anti-tax avoidance rules (GAAR), outlined in Chapter 10 of Circular 2 (Articles 92-97), may increasingly come into play.

Chinese tax officials are explicitly empowered by law to investigate using GAAR if tax avoidance arrangements are identified in relation to abusive use of preferential tax arrangements, abusive use of tax treaties, abusive enterprising structures, tax avoidance by means of tax heavens or other arrangements without reasonable business purposes. In the context of the BEPS initiative, taxpayers should pay attention to the commercial substance of their overseas related parties with which Chinese entities have cross-border transactions, especially group entities established in suspected tax heavens. Chinese tax officials are increasingly familiar with tax structures commonly adopted by MNEs, and the Ministry of Commerce publishes information on foreign direct investment (FDI) on its website ( For example, based on such statistics, FDI into China from Hong Kong has been roughly half of the total annual FDI into China, and FDI from the British Virgin Islands has been a multiple of that from the US in several years. Given the BEPS Action Plan, existing Chinese GAAR and the increasing sophistication of Chinese tax officials, special considerations should be given by taxpayers to the staff employed, assets utilised, risks assumed and decision-making capabilities of these overseas related entities in the future.

Transfer pricing regulations going forward

Circular 2 was published in 2009, retroactively effective as of January 1 2008, as a provisional measure to provide guidance to Chinese tax officials and taxpayers regarding transfer pricing and certain other tax matters, such as GAAR, controlled foreign corporations, and thin capitalisation. In response to observed practical implementation issues and the ever-changing transfer pricing environment both inside and outside of China, we expect that a revision of Circular 2 will be forthcoming. Although it is not known when a revision will be adopted, or what the exact changes will be, based on our experience during the years since the adoption of Circular 2, possible areas of interest to taxpayers that could be touched on might include:

  • Guidance on GAAR for implementation purposes;

  • Transfer pricing method(s) for related-party share transfers;

  • Transfer pricing documentation thresholds;

  • Disclosure requirements, for example regarding country-by-country reporting, or greater disclosure obligations for overseas related parties;

  • Issues mentioned in the UN TP Manual CCP, such as location specific advantages, service fee deductions, and locally-generated intangibles; and

  • Guidance on avoiding double taxation as a result of the self-adjustments in the five-year follow-up period post transfer pricing audits.

Expert panel

Pursuant to internal procedures announced in 2012, the SAT has established an expert panel mechanism to provide professional opinions on transfer pricing audit cases where:

  • The registered capital of the entity under review exceeds a certain threshold or the entity has an annual average operating revenue above a certain threshold; or

  • There is an industry-wide or nationwide investigation; or

  • The Chinese tax authority considers the case to be significant.

Some tax authorities at provincial and municipal levels, such as in Guangdong province, have established expert teams to review and assess the technical merits and adjustment scenarios of transfer pricing audit cases. It should be noted that since this creates one more body to review the methodology, audits going through expert panel review have the potential to proceed more slowly.

The expert panel at the SAT-level aims to standardise the transfer pricing investigation procedures across all levels of the Chinese tax authority. Feedback provided to the audit working team after the expert panel review is intended to improve the quality of analyses and materials supporting the transfer pricing adjustments. It is also worth noting that the expert panel review result (for example profit range and adjustment method) of an industry-wide transfer pricing audit may be viewed as a precedent case for future audits in the same industry.

Leading voice

Many of the ideas proposed in the BEPS Action Plan are consistent with trends we observe having taken place in China in recent years. As the BEPS proposals are refined and the position of the Chinese tax authority crystallises, this represents an area of importance which taxpayers should follow closely. At the same time as the SAT is becoming a leading voice in these international discussions, it is domestically proceeding at a rapid pace to advance its agenda of staunchly defending its tax base, including focusing on service fees, locally-created intangibles, revising domestic tax regulations and increasing the sophistication of its analyses. Taxpayers should pay close attention to these trends, as they could potentially broaden the depth and scope of tax investigations in the future.



Brett Norwood

KPMG China

50th Floor, Plaza 66

1266 Nanjing West Road

Shanghai 200040


Tel: +86 (21) 2212 3505

Fax: +86 (21) 6288 1889


Brett Norwood is a partner and PhD economist with KPMG's global transfer pricing services, based in Shanghai. Before joining KPMG, he held positions with another Big 4 firm in New York, and more recently in Beijing for nearly six years.

Brett frequently speaks at industry events, tax forums and webinars and often gives presentations in Chinese to local, provincial and national level tax authorities.

Brett has led the documentation efforts for companies with several dozens of entities across China, advised taxpayers regarding their transfer-pricing audits in China, and also advised multiple-state and privately owned China-based companies expanding their operations overseas. In the US and China, he has served clients in a variety of industries including financial services, consumer goods, manufacturing, automotive, advertising/marketing services, etc., analysing cross-border transactions in Asia, Europe, and America. Brett has been recommended as a leading transfer pricing advisor in China by the Legal Media Group since 2011.



Cheng Chi

KPMG China

50th Floor, Plaza 66

1266 Nanjing West Road

Shanghai 200040


Tel: +86 (21) 2212 3433

Fax: +86 (21) 6288 1889


Based in Shanghai, Cheng Chi is the partner-in-charge of KPMG's global transfer pricing services for China and Hong Kong S.A.R. Before returning to China in 2004, Cheng started his transfer pricing career in Europe with another leading accounting firm based in Amsterdam. He has led many transfer pricing and tax efficient supply chain projects in Asia and Europe, involving advance pricing arrangement negotiations, cost contribution arrangements, Pan-Asia documentation, controversy resolution, global procurement structuring, and headquarters services recharges for clients in the industrial market including automobile, chemical, and machinery industries, as well as the consumer market, logistic, communication, electronics and financial services industries .

In addition to lecturing at many national and local training events organised by the Chinese tax authorities, Cheng has provided technical advice on a number of recent transfer pricing legislative initiatives in China. He has been recommended as a leading transfer pricing advisor in China by the Legal Media Group.



Kelly Liao

KPMG China

38th Floor, Teem Tower

208 Tianhe Road

Guangzhou 510620


Tel: +86 (20) 3813 8668

Fax: +86 (20) 3813 7000


Kelly Liao is a partner in KPMG's Global Transfer Pricing Services group, based in Guangzhou. Kelly has working experience in China, Hong Kong and Finland.

Prior to joining KPMG, Kelly worked in another Big Four accounting firm specialized in transfer pricing practice. She has been actively assisting multinational companies in transfer pricing dispute resolution, tax efficient supply chain planning, rationalising transfer pricing policies, formulating cost recharging policies and applying for Advance Pricing Arrangements in China.

Prior to 2003/2004, Kelly also assisted many multinational companies in corporate tax advisory and merger & acquisition tax advisory.

Kelly's clients include a number of multinational and domestic enterprises in wide range of industries, including consumer goods, retail, chemical, electric and electronics, property development, pharmacy, machinery, and etc.



Irene Yan

KPMG China

8/F, Office Tower E2, Oriental Plaza

No. 1 East Chang An Ave.

Beijing 100738


Tel: +86 (10) 8508 7508

Fax: +86 (10) 8518 5111


Irene Yan joined KPMG Beijing in 1993. With more than twenty years experience with KPMG, Irene has broad knowledge in various PRC taxes, including, particularly, corporate income tax, indirect tax and individual income tax.

Irene has conducted research and has been actively involved in PRC inter-company transfer pricing practice since late 90s. She has rich experiences in group tax optimization, Tax Efficient Supply Chain Management, transfer pricing risk assessment, economic analysis, cost sharing arrangement, transfer pricing dispute resolution, advanced pricing agreement and contemporaneous documentation. Her experiences cover diverse markets, such as pharmaceutical, chemical, energy, food, retail, automotive and information industries. Her clients include a number of multinational enterprises with investment in China as well as large-scale state-owned enterprises and private companies with outbound investment.

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