Mainland targets foreign tax cheats
Toh Han Shih
Officials step up crackdown on illegal transfer pricing that has cost the state about 300m yuan a year
Foreign firms in China face closer scrutiny as the government moves to bring in an estimated 300 million yuan a year it says slips through the tax net via illegal transfer pricing.
A new requirement expected this year requires foreign-invested entities to submit regular documentation on their transfer pricing activities - the prices charged in transactions between a foreign firm's Chinese subsidiary and its subsidiaries in other jurisdictions.
Tax authorities suspect many foreign firms avoid China taxes and repatriate profits by buying high and selling low to related parties overseas, according to a paper by PricewaterhouseCoopers.
For example, a multinational's factory in China may sell goods cheaply to its Hong Kong office, which exports the goods at much higher prices to minimise its taxes because Hong Kong taxes are lower than the mainland's.
'Very likely, the documentation requirement will be started by the State Administration of Taxation in a matter of months,' KPMG partner Steven Tseng Shih-ting said. 'China wants to make sure multinationals pay their share of tax.'
Firms would be required to file regular self-audits of transfer pricing and profits to tax authorities, Mr Tseng said.
Although China strengthened its transfer pricing laws in 2004, enforcement remained weak, he said. By the end of 2004, tax authorities had audited and investigated fewer than 12,000 of about 500,000 foreign-invested entities.
'Enforcement efforts by the tax administration are expected to increase this year. It has conducted restructuring of its anti-tax avoidance team and organised training programmes for [team] officials and transfer pricing specialists at the provincial tax authorities,' Mr Tseng said.
Such investigations can be traumatic for some overseas firms. In 2000, tax officials raided the accounting offices of Perennial International, a Hong Kong-listed maker of electric cables, seizing documents and computers, said Florence Tsang Li Man-wai, who worked for the firm.
KPMG's Mr Tseng said: 'Without a documentation requirement, Chinese tax authorities have to resort to audits, to be suspicious of non-compliance of transfer pricing laws by companies and investigate them. The Chinese authorities are turning this around by forcing every foreign-invested enterprise to produce a tax report.'
It will be increasingly difficult for companies to cheat on such reports, he said. Transfer pricing involves transactions between China and other countries, so the Chinese authorities could cross-check companies' transfer pricing with other countries, he said.
Almost 30 countries have adopted this documentation requirement on transfer pricing, including key trading partners such as the United States, Germany and Japan, and more are set to do so, Mr Tseng said.
Hong Kong has yet to adopt the documentation requirement.
However, such transfer pricing issues will not affect many of Hong Kong's manufacturers as most in southern China engaged in textiles, watches, toys and electronics are 'outward processing factories', said Willy Lin Sun-mo, vice-chairman of the Hong Kong Textile Council.
Foreign-invested factories in which all raw materials are imported and all finished goods exported, are exempt from tax.
'China doesn't have enough high-quality accountants to handle the tax accounts of all 500,000 foreign-invested entities in the country. This is going to be a major problem,' Mr Lin said.