Year-end TP adjustments in China: feasibility and current practice

Despite not being a member of the OECD, China adopts key concepts and methodologies introduced by the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations while structuring its own transfer pricing (TP) legislative framework. This framework is anchored in the arm’s-length principle. The competent tax authorities are empowered to conduct special tax adjustments against China taxpayers whose intragroup transactions are not at arm’s length.

To help TP compliance, subsidiaries of a multinational company (MNC) should consider year-end TP adjustments (TPAs) to achieve targeted arm’s-length profit margins. Such adjustments correct variances between actual and targeted arm’s-length profit margins caused by operational factors within the year.

A year-end TPA involves a one-off accrual or reversal of profit by local subsidiaries to adjust the taxpayer’s profitability to an arm’s-length level. Crucially, to mitigate double taxation risk, the year-end TPA must be reflected in the accounts and tax returns of the relevant entities. To further mitigate Chinese foreign exchange (FX) risk and associated enterprise income tax risk stemming from long-outstanding accounts receivable or accounts payable on the books of the Chinese entity, the accrual or reversal must be settled through cash receipts or payments.

As cash settlement is mandated, TPAs in China normally require consideration of not only local tax rules but also banking and FX regulations, due to China's FX controls. Consequently, implementing a successful TPA in China generally involves not only TP compliance but also adherence to local FX rules and bank processing procedures.

This article summarises the current rules and practices related to implementing year-end TPAs in China based on the authors’ observations.

The boost in foreign investment in recent decades in China has led to many MNC subsidiaries transacting with their overseas related parties. Consequently, TPA has become a hot topic that taxpayers frequently discuss with their tax advisers. Based on market observations, taxpayers may face the following challenges regarding TPA.

In general, the settlement of an outbound TPA (i.e., the outbound payment for the purpose of a TPA) associated with the product pricing from an FX perspective will need revised customs certificates for imports and exports. However, rare cases of outbound TPAs in China have been settled from an FX perspective via successfully convincing customs by issuing revised customs certificates with upwardly adjusted prices of imported goods or downwardly adjusted prices of exported goods. This approach is not representative, is usually time-consuming, and involves a high degree of uncertainty. Consequently, outbound TPAs are generally not feasible in China due to FX control requirements and the difficulty in obtaining revised customs certificates.

Unlike outbound TPAs, inbound TPAs are feasible, as the State Administration of Foreign Exchange (SAFE) has specifically waived the requirement of revised customs certificates in handling FX receipts of inbound TPAs. The SAFE Shanghai bureau started this policy in 2020 as a pilot programme in Shanghai and it expanded nationwide via SAFE guidelines.

For inbound TPAs where foreign currency was received by Chinese MNC subsidiaries, SAFE is the governing authority, and SAFE-designated commercial banks handle execution. These commercial banks review the application package submitted by taxpayers and process the receipt of funds, in compliance with SAFE guidelines and their internal risk management procedures.

Accordingly, Chinese-based taxpayers are advised to monitor TP performance throughout the year to avoid year-end outbound TPAs. Where an outbound TPA is unavoidable, practical measures should be adopted to identify solutions by weighing relevant risks and benefits.

For intercompany transactions involving service fees and royalties, implementing year-end TPAs (both inbound and outbound) can be accomplished by carefully drafting flexible intercompany agreements. This is because settling service fees and royalties typically does not require customs certificates, and agreements can incorporate provisions for year-end true-ups or true-downs without significant FX control difficulties, provided they are drafted with due care.

SAFE has published general guidelines and rules for inbound TPA settlement. Commercial banks, as financial institutions, are responsible for the execution of inbound TPAs and will follow those general guidelines by consulting with the local bureau of SAFE during the process. Moreover, commercial banks normally need to adhere to internal risk management procedures. Consequently, inbound TPA procedures may vary by location, and even within the same location, minor variations may exist between banks.

The general procedure requires taxpayers to submit an application package for desktop review by the designated processing bank. Documentation requirements can vary but generally include an explanatory letter, TP analysis, computation worksheets, and intercompany agreements. To ensure independence, taxpayers typically compile these materials with support from third-party accounting firms or professional tax advisers. Many banks, in fact, require the analysis to be issued and certified by a third party.

Some banks in certain locations do not require a formal acknowledgement notice or input from local tax authorities. Others may request a formal notice from the tax authorities regarding an inbound TPA. Formal tax authority endorsement or agreement on the TP policy is not typically required to process an inbound TPA, as tax authorities reserve their assessment rights.

The effort required to obtain tax authority acknowledgement notice varies by location. In certain locations where the local SAFE bureau, banks, and tax authorities can be much more risk-averse, obtaining acknowledgement may require substantial effort or become a roadblock. It is noteworthy that in June 2025, the Shenzhen municipal tax bureau announced the introduction of a mechanism to issue a formal notice for inbound TPA purposes. A more detailed discussion on this new municipal regulation follows.

Traditionally, TPAs were viewed as special tax adjustments impacting only corporate income tax. However, some local tax authorities have recently questioned potential turnover tax (e.g., VAT) implications, considering the nature of the TPA and the underlying related-party transactions. For example, if the TPA effectively constitutes pricing adjustments for historical intercompany services, some tax authorities may treat it as VAT-able. Therefore, it is necessary to carefully consider the basis for the TPA and whether it can be reasonably defended as exempt from turnover taxes.

To standardise inbound TPA implementation in Shenzhen, the Shenzhen tax authority issued guidance on inbound TPA settlement on June 23 2025.

According to the guidance, taxpayers in Shenzhen voluntarily performing an upward tax adjustment via an inbound TPA can apply for a formal notice from the fourth branch of the Shenzhen municipal tax authority. Applicants must submit a narrative explaining the background of the special tax adjustment and the corresponding intercompany agreement for the TPA arrangement for the tax authorities’ desktop review. If approved, the tax authority will issue a notice within five business days of accepting all the required application materials.

The Shenzhen guidance explicitly states that the notice does not constitute tax authority endorsement of the TPA’s arm’s-length nature. Instead, it merely aims to facilitate the processing banks’ review and support taxpayer compliance efforts. This approach resembles practices in some other locations, although Shenzhen is the first to formalise it publicly.

TP compliance has become more vital for smooth business operations in China, catalysed by the increased TP compliance enforcement and risk assessment effort by the tax authorities, together with the greater revenue pressure on the tax authorities in the post-COVID era. Therefore, MNC subsidiaries are recommended to construct a whole life cycle framework to manage TPAs. This prospective control aims at the timely execution of intragroup agreements, the avoidance of outbound year-end TPAs, and the preparation and filing of documentation to ensure a smooth inbound TPA.

Management is also advised to engage professional third-party tax advisers to review and assess the tax implications of inbound TPAs when executing adjustments. Preparing strong supporting materials and maintaining clear communication with banks (and, where needed, with the tax authorities in some locations) during the inbound TPA process are also critical for success.

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