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China: China finalises transfer pricing guidance

Khoonming HoLewis Lu

Key clarifications were made to China's transfer pricing (TP) guidance recently. This included both the finalisation of guidance "localising" the OECD's BEPS TP work for China and clarifications on TP documentation and reporting requirements.

On March 28 2017, the State Administration of Taxation (SAT) released its long-awaited announcement on special tax investigations, adjustments and mutual agreement procedures (Announcement 6). Work on this document commenced more than half a decade ago to update the earlier Circular 2 [2009] TP guidance. As the BEPS Project (2013-15) advanced, various strands of the BEPS TP work were integrated into successive drafts, with a public consultation draft released in September 2015 containing many BEPS elements. The final Announcement 6 reflects the September 2015 draft.

Announcement 6 contains substantially revised procedural guidance for TP investigations and for mutual agreement procedures (MAP). It formalises many of the TP administrative practices developed since Circular 2 in 2009, as well as consolidating various pieces of SAT guidance issued in the meantime. Among the matters covered are the procedures for TP self-adjustments, special rules on TP adjustments for toll manufacturers, a nuancing of restrictive provisions on deductions for payments to low substance foreign entities, requirements on minimum profit expectations for single-function entities, and guidance on tested party selection. The SAT's favoured concept of location specific advantages (e.g. market premium, cost savings), for which China obtained greater recognition in the BEPS Actions 8-10 TP guidance, is formalised in Announcement 6. The MAP guidance is directed, together with the boosting of MAP personnel at the SAT, towards meeting China's BEPS Action 14 commitments. Advancing on the September 2015 draft, Announcement 6 also includes provisions directed at untangling hidden or offsetting transactions and to confirm the SAT's right to audit non-resident, as well as resident, entities. In a step away from the September 2015 draft, Announcement 6 deletes the proposed value chain apportionment method (VCAM), which had earlier generated concerns among enterprises.

Announcement 6 also includes the SAT's highly anticipated guidance on TP for intangible assets and services. Although the intangibles guidance draws on the BEPS concept of DEMPE functions (development, enhancement, maintenance, protection, exploitation) for allocating profits from intangibles in line with value creation, it preserves and supports existing Chinese TP practices regarding intangibles. Existing practices, now reinforced, encompass the concept of 'local intangibles', owned by Chinese entities in a multinational enterprise (MNE) group and created via manufacturing or marketing experience, and a focus on limiting deductions for outbound royalties. This is achieved by extending the DEMPE concept to DEMPEP (promotion), de-emphasising the role of high-level control functions in the creation of value in intangibles (the OECD's preference) in favour of the more hands on production and marketing activities, and by providing guidance on adjusting downwards deductions for outbound royalties over time.

The new provisions on services consolidate existing TP guidance. They are largely in line with OECD guidance, but are more restrictive towards many types of group-wide services. These are treated to a greater degree as shareholder activities, for which no tax deduction is available. The SAT also, in Announcement 6, declines to adopt the BEPS-proposed safe harbour for low-value adding services on the basis that all related party service transactions are high risk.

Separately, on March 27, the SAT issued a notice clarifying various aspects of TP documentation and reporting requirements, following on from the revised China TP documentation guidance set out in SAT Announcement 42 in June 2016. These matters include, inter alia, the accounting standards to be used in preparing country-by-country (CbC) reports, time extensions for surrogate CbC filings, and master file requirements for joint venture enterprises.

With these clarifications, China has gone a long way towards the completion of its upgraded framework for TP. It remains to be seen how, in practice, the new TP information sources available to the authorities will be used in light of the new rules, and how effectively the upgraded (and better resourced) MAP programme will operate.

Khoonming Ho ( and Lewis Lu (
KPMG China
Tel: +86 (10) 8508 7082 and +86 (21) 2212 3421

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