Challenges in implementing TP adjustments in China: Are there effective solutions?
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Challenges in implementing TP adjustments in China: Are there effective solutions?

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Xiaoyue Wang and Choon Beng Teoh of KPMG China explain the complexities of performing year-end transfer pricing adjustments in China, including their impact on customs and indirect taxes, and the possible longer-term solutions taxpayers can consider in managing their TP arrangements.

Most subsidiaries of multinational enterprise (MNE) groups in China adopt a limited risk business model. The limited risk model requires that the transfer pricing (TP) results and profits of the China MNEs’ related party transactions are kept at levels comparable to other unrelated parties in the market that undertake similar functions and risks. Under this method, the tax authorities not only pay attention to the transaction prices, but they also pay more attention to the profit level of the MNEs.

There are various reasons as to why TP policies set at the beginning of the year do not achieve the arm’s length results as intended. One reason is that TP policies are generally set using forecast data, but the actual data turns out to be different. Other reasons, such as changes in the external business environment and other uncontrollable factors – e.g., the COVID-19 pandemic – also may have caused the implementation results of MNEs to deviate from their TP policies. Retrospective year-end TP adjustments are thus required to bring the actual results to the arm’s length standard.

Performing retrospective TP adjustments in China, however, is more complex in practice than in many other jurisdictions, primarily due to the strict foreign exchange controls of the State Administration of Foreign Exchange (SAFE). The difficulty of settling foreign exchange would mean that the TP adjustment entries could not be booked in the accounts of the MNEs, thereby increasing their TP risks.

Retrospective TP adjustments would also have an impact on customs duties and indirect taxes, and MNEs should also consider these impacts. Managing TP adjustments from a customs perspective is vital to ensure customs compliance so that trade is not disrupted.

Upward and downward TP adjustments

TP adjustments can go either way – an upward adjustment is to increase the profitability of the MNE, while a downward adjustment reduces the taxable profits of the MNE.

Upward adjustments are more commonly seen in China. Generally, the adjustments would not likely create adverse reactions from the tax authorities as this would enable MNEs to eventually pay more corporate taxes, although the adjustments do not protect the MNE from future TP audits.

Often, upward TP adjustments in China are processed as service fee transactions. The China foreign exchange controls provide that foreign exchange is processed either through the trade route (i.e. physical goods trades) or the non-trade route (generally services or royalties). If the TP adjustment is not related to goods transactions, then the banks would process the adjustment as a service transaction despite the fact that it does not involve the provision of services. This could raise issues for the overseas related party whereby the substance of the “service” transaction is questionable. Furthermore, VAT would need to be charged by the local MNE to the overseas related party when the adjustment is processed as a service fee. This would be a leakage to the overseas related party given that China VAT is not creditable in its jurisdiction.

Even if the TP adjustment is related to goods transactions, it is generally not possible to obtain documentation from the customs authorities to re-adjust the import prices. In an upward TP adjustment, a refund on the customs duties and import VAT already paid should in theory be due, but there has not been any precedent where an MNE importer has been able to obtain a refund.

SAFE has piloted certain programmes to streamline the procedures for Chinese MNEs to receive TP compensations from overseas related parties and, if ascertained as authentic transactions and compliant, they could be processed through other accounts instead of the trade or non-trade accounts. As a result, there are some successful cases where upward TP adjustments are processed through the new category and not as service transactions. The process, however, is not straightforward. It commonly requires multiple rounds of communication with the bank (or multiple banks, because the practices vary) and also discussions with SAFE to obtain specific approvals. The tax authorities would also need to be consulted so that they agree that the adjustments would not be subject to VAT.

In contrast, retrospective downward TP adjustments are generally difficult to execute in China. Chinese tax authorities would not endorse any adjustments that reduce the tax base of the MNEs. MNEs would usually put in place transactions like service fees or licensing transactions to manage their profit margins prospectively. These are not necessarily effective if the profits are high, plus there are withholding taxes and VAT implications. Tax authorities, meanwhile, target these transactions as low-hanging fruit for TP audits.

Profitable MNEs also face scrutiny by the customs authorities on the import prices for being low due to TP. The risk is elevated if these MNEs also pay royalty fees. The licensing arrangements are construed by customs authorities as a way to reduce prices of imported goods, thereby reducing the payable duties. Performing a downward TP adjustment would, in theory, mitigate the customs risk by adjusting upwards the import prices and paying the additional duties and import VAT. However, in practice, the Chinese customs authorities do not usually re-open filed declarations or issue a proforma customs declaration (i.e. declarations that do not refer to underlying imports) to adjust the import prices upwards, hence creating difficulties for MNEs to provide the necessary documentation to banks to process the downward adjustments.

Clarifications issued by SAFE

Recognising the lack of clarifications on how foreign exchange regulations process TP adjustments and collecting the experience from the SAFE pilot programmes noted above, SAFE issued a notice titled “Questions & Answers Regarding Foreign Exchange Administration for Services and Trade (II)” (SAFE Q&A) in January 2021, wherein one part of the SAFE Q&A is aimed at TP adjustments and clarifies how banks process inbound or outbound cashflows as a result of TP adjustments.

The Q&A provided three approaches where TP adjustments could be processed: (1) Foreign exchange inflows or outflows based on TP methods; (2) Foreign exchange inflows or outflows using the cost sharing method; and (3) Foreign exchange inflows or outflows using other methods.

“If a TP adjustment is unavoidable at the year-end, MNEs should provide sufficient time to process the adjustment and prepare adequate documentation, as well as be aware of the relevant customs and indirect tax implications.”

Under the first approach, the banks processing TP adjustments would need to “review the relevant written documentation issued by tax authorities or customs authorities, profit adjustment agreements, and invoices”. The foreign exchange payments or receipts would then be processed to follow the original transaction types. The SAFE Q&A does not provide further clarification on the format of the documentation issued by the authorities that can be accepted by banks.

In practice, the tax authorities generally will not issue any official written documentation or notices to taxpayers. The written documentation that can be issued is usually limited to when there is an advance pricing agreement (APA) in place or when TP audits had been concluded. From a customs perspective, as discussed above, customs authorities do not entertain the re-opening of customs declarations or the issuing of a proforma declaration even if there is additional duty to be collected, except for the conclusion of a customs audit.

Under the second approach, the SAFE Q&A’s reference to cost sharing method is not the general TP understanding of a cost contribution arrangement. In substance, MNE groups may centrally appoint a group member to enter into contracts with third parties or related parties. MNEs would thus need to prepare the relevant TP documents to demonstrate that the cost sharing method is consistent with the arm’s length principle. It is then up to the interpretation of the banks to review the relevant documentation to affirm that these transactions are not related to insurance compensation.

The third approach is a catch-all statement to allow SAFE bureaus and banks the flexibility to deal with foreign exchange cash movements to take into account the different TP arrangements or business models of MNE groups.

The SAFE Q&A has been issued for over a year but it is still generally difficult to have a harmonised practical approach. There is a need for MNEs to discuss with banks and/or local SAFE individually to determine the local interpretation of the SAFE Q&A.

Longer-term solutions

TP adjustments are only short-term solutions performed in any one year to bring the MNEs’ profitability to meet the arm’s length principle. The complex process of communicating with banks, SAFE, customs and tax authorities as discussed above would have to be repeated whenever a TP adjustment is required.

The most efficient way of managing TP policies is to have a strong monitoring mechanism to identify any deviations early on and undertake measures to mitigate the deviations. This is where operational TP (OTP) comes into play. OTP is a framework that incorporates the lifecycle of TP from policy conceptualisation to implementation. The OTP solutions take into account process and policy improvement, governance and controls, finance system readiness and technology automation to achieve successful implementation of TP policies.

Alternatively, MNEs could also explore other ways to manage their TP policies more effectively, such as applying for an APA, either bilateral or unilateral, so that TP arrangements and adjustments can be agreed in advance. An APA agreement is a document issued by the tax authorities, thus fulfilling the first approach of the SAFE Q&A. The APA is also generally respected by the Chinese customs authorities and as such any customs risks could also be mitigated to a large extent.

Despite the benefits, APAs often take a long time to negotiate and conclude regardless of whether the APA is unilateral or bilateral. A unilateral APA process would typically take two to three years and the process could be longer for bilateral APAs.

China’s State Taxation Administration (STA) issued a regulation in July 2021 introducing a new set of simplified procures for unilateral APAs (but not bilateral APAs). MNEs will need to meet certain criteria to be able to apply the simplified procedures. The new regulation reduces the APA process from the general six stages to three and also provides specific timelines for each stage of the process. This means that unilateral APAs could potentially be concluded within one year of submitting the application. This is part of the STA’s continuous innovation to improve its services to taxpayers. Prior to the official roll-out, when the rules were trialled in southern China, the authors successfully obtained agreements through the simplified procedures within nine months of the date of application.

Continuing with the theme of innovation, China is also trialling a pilot case in southern China to resolve the double taxation of corporate income and import pricing under an APA/joint-ruling framework between tax and customs authorities. The case discussions are at an advanced stage, and if the case is successfully concluded, it would pave way for future cooperation between the STA and the customs authorities at the central level to make this dispute resolution channel available to other provinces and cities. This will undoubtedly facilitate cross-border trades and, as far as the authors are aware, would also make China the first country to be able to resolve the issue of tax and customs double recognition and taxation of the same transactions.

Key takeaways

Managing TP policies is arduous, particularly if there are no systematic processes in place that would provide an accurate view of the MNE’s profitability before the accounts close. The concerns discussed in this article would not be an issue if MNEs were able to manage their TP prospectively deploying solutions such as the OTP mechanism. If a TP adjustment is unavoidable at the year-end, MNEs should provide sufficient time to process the adjustment and prepare adequate documentation, as well as be aware of the relevant customs and indirect tax implications.

For longer-term solutions, APAs could be considered as they effectively minimise the relevant tax and TP risks. China’s introduction of simplified procedures that effectively reduce the timeframe to conclude a unilateral APA is an attractive alternative for MNEs. Further, if the tax and customs joint-ruling mechanism is successfully introduced in China in the future, it would be a powerful dispute resolution mechanism whereby tax/TP and customs risks can be mitigated at the same time.

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Xiaoyue Wang


National head of transfer pricing

KPMG China

T: +86 10 8508 7090


Xiaoyue Wang is the partner in charge of the TP practice at KPMG China.

Xiaoyue leads various large TP and tax policy consultation engagements, including the design and set-up of tax systems for outbound enterprises, design of global tax structures and value chain arrangements, formulation and implementation of MNE’s related-party TP management system, preparation of TP compliance documentation such as country-by-country reports, application of bilateral advance pricing agreements and mutual agreement procedures for MNEs, etc. Xiaoyue has extensive experience in assisting multinational companies in achieving global TP and tax compliance, as well as effectively mitigating and addressing global tax risks. Her clients comprise MNEs with global operations in a wide range of industries, including electronics, automobile, finance, consumer goods, telecommunication, real estate, pharmaceutical, luxury industries, etc.

Xiaoyue is a member of the transfer pricing subcommittee of the Committee of Experts on International Cooperation in Tax Matters of the United Nations.

Choon Beng Teoh



KPMG China

T: +86 21 2212 4527


Choon Beng Teoh is a director with the global TP team of KPMG China and is based in Shanghai.

Choon Beng has experience in multi-jurisdictional planning studies, dispute resolution, value chain analysis and restructuring of operating models, as well as leading and managing global TP documentation projects. His client portfolio includes top-tier multinational companies across a variety of industries, including pharmaceutical, automotive and retail. He also occasionally co-authors articles on China-related TP topics for publications.

Choon Beng graduated with a law degree from the London School of Economics and is a chartered accountant with the Institute of Chartered Accountants in England and Wales. Prior to joining KPMG China, he practised in another leading accounting firm in London in the area of international tax and TP matters.

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