New rules put intercompany arrangements in the spotlight

Mainland tax authorities recently launched a series of initiatives to address tax avoidance concerns, driven mainly by the question as to whether corporate taxpayers are shifting profits offshore.

Transfer pricing is a key focus of these initiatives. Transfer pricing refers to intercompany pricing arrangements between related business firms. It commonly applies to cross-border transfers of tangible and intangible property between associated companies in a group.

The mainland requires companies to report annually on transfer pricing transactions between associated enterprises and has been questioning situations where it perceives that arm's length prices agreed between related parties - each party earning a profit according to its functions and risks, as if it is an independent enterprise - have not been used.

To strengthen its enforcement of transfer pricing, the State Administration of Taxation (SAT) issued new transfer pricing legislation in January, the Implementation Measures for Special Tax Adjustments (trial version).

The circular mandates an annual compliance requirement and introduces nine new tax filing forms. It sends a strong message to taxpayers that the SAT is taking transfer pricing seriously, according to Cecilia Lee, a Hong Kong-based transfer pricing partner with PricewaterhouseCoopers. 'These measures have a much stronger compliance requirement than before. Taxpayers now need to prepare documentation and reports to support that their transfer pricing arrangement is being done on an arm's length basis,' she said.

In practice, taxpayers are required to prove to the tax authorities that their intercompany transfer pricing policy is not tax-driven. To comply with special tax adjustments, taxpayers on the mainland must submit the new annual reporting forms on their intercompany transactions along with their annual tax filing forms. Among the information required is a list of related parties, transaction summaries, details of intangible assets, fixed assets and financing plus annual reporting of overseas investments and foreign remittances.

These disclosures must also be accompanied by an indication as to whether the documentation is in place; an explanation on which pricing method has been adopted for related party transactions; and a comparison between key overseas related party transactions and third party transactions.