New regulations on transfer pricing will have far-reaching implications for financial services companies doing business on the mainland. While the regulations are another step forward in bringing the mainland's tax regime in line with international norms, they also represent a further attempt to protect tax revenue. In January this year, the State Administration of Taxation promulgated a circular affecting associated businesses that carry out transactions with each other. Transfer pricing places value on transfers of goods or services within an organisation, and is used as a means of allocating revenue and costs to various profit centres. It also acts as a price setting mechanism for services performed by business units and is a means of evaluating financial performance by different units, and determining contributions to net income by different profit centres. According to Michael To, executive director, Mazars, Hong Kong, the mainland is moving towards an international tax system and adopting international tax practices. 'If you have cross-border transactions dealing with your related parties you are supposed to conduct these transactions on an arm's length basis,' he said. 'Everything is measured with reference to the prevailing interest rate so you have to comply with this benchmarking of the interest rate applied to the loans you are lending to related parties in China,' he said. Under the new regulations, businesses will need to analyse the functions performed and the risks assumed. It will be necessary to determine an arm's length price, to raise an inter-company charge or invoice, and then to rigorously document exactly how that charge was determined. For last year's tax returns, all businesses will have to complete nine new filing forms. For taxpayers who trigger the documentation threshold - more than 200 million yuan (HK$227 million) of tangible goods transactions or 40 million yuan service transactions - they are required to prepare a specific transfer pricing documentation report. This report requires a large amount of detail regarding the business, the related party transactions, the industry, the functions, the financials and the comparables. For financial services organisations, completion of the nine forms is already throwing up some challenges, according to Justin Kyte, director, Global Transfer Pricing Services, KPMG China. 'None of these forms was designed with financial institutions in mind,' he said. 'Banks that do overnight borrowing and lending with an in-house treasury function, or financial institutions that engage in financial trading and insurance companies are already questioning which form they put their financial transaction details onto.' A second issue will be the lack of experience on the part of the relevant tax authorities in financial services transfer pricing, which is quite specific and complex, according to Kari Pahlman, Hong Kong-based director at KPMG China's Global Transfer Pricing Services. 'Typically, financial services institutions have a huge number of related party transactions and run integrated operations with high value activities in numerous locations. This will typically require more complex transfer pricing methods. As transfer pricing in China has traditionally focused on manufacturing and distribution, there may be difficulties in terms of understanding the financial services business and its transactions,' he said. 'It's foreseeable that the Chinese authorities will see that the financial services industry is something they need to learn about and may take a more long-term view on. They are likely to use the documentation obligation primarily first to educate themselves. Many financial institutions could expect their documentation to be requested because the authorities will want to see what the sophisticated multinationals do and learn about this area,' he said. Jessica Tien, a Shanghai-based partner with Ernst & Young, said that accountants working with financial services organisations, involved in related cross-border transactions, should seriously consider the consequences of not complying with the disclosure and documentation requirements. 'The cost of doing cross-border transactions in terms of those transactions involving China has to increase, the risk profile has increased,' she said. 'So companies have to have very good internal control and documentation of everything they're doing in the related party transaction area to mitigate any potential controversy. 'It's worth noting that China is very proactive in pushing for a more mutually friendly environment to discuss transfer pricing uncertainties. They have a very strong advanced pricing agreement so companies with high uncertainty should consider using this as a vehicle to mitigate future risk.' The new regulations also offer the opportunity for finance or tax directors to be strategic about their tax planning. This year, there are two deadlines: the forms are due on May 31 but the documentation, which will detail the economic rational for given price or profit levels, is due on December 31. In the real world, this may mean that finance professionals won't know upon filing the forms whether there is good evidence or support that the related party transactions are concluded correctly. 'Generally, before engaging with this compliance, taxpayers should carefully assess their risk first,' Mr Pahlman said. 'They should look at their transfer pricing position in China, form a view as to whether they have material transactions and exposure, and then tailor the documentation approach accordingly. They should also commence the documentation process before completing the forms.' Taxpayers on the mainland are advised to get a clear picture now of their compliance strategy, with a view on the level of support in terms of market data, or distribution of risk and economic activity between onshore and offshore subsidiaries in the group. This means that when they fill the information out on the forms there is a good chance that it will be supported by the more detailed documentation work done after May 31.